BBSW – Page 4 – Digital Finance Analytics (DFA) Blog

ASX To Administrate BBSW From 1 Jan 2017

Last week, the Australian Financial Markets Association (AFMA) announced that it will transfer administration of the BBSW benchmark rate to ASX. It is the intention of both parties that ASX will administer BBSW from 1 January 2017.

ASX was selected following a highly competitive process, which began in July 2016 with a public invitation for interested parties to register their interest as a potential alternate benchmark administrator for BBSW.

Ernst & Young provided financial advisory services to AFMA for the externalisation process, while Mills Oakley acted as AFMA’s legal adviser.

“AFMA is delighted to have found in the ASX an organisation with strong credentials to take responsibility as administrator for BBSW,” said AFMA’s CEO, David Lynch. “ASX has the appropriate attributes as a benchmark administrator and it has a strong and unique capability to continue the work underway to transition the BBSW methodology to a VWAP process.”

For further details on the methodology transition process, please refer to AFMA Market Notice 2016_5. AFMA will support the future evolution of BBSW by working with ASX, market participants and the Council of Financial Regulators to promote the market infrastructure and practices required to support widespread trading at outright prices in the underlying market. AFMA will also operate as the calculation agent for ASX until the systems required to support the new methodology go live in 2017.

Today’s announcement will allow AFMA to focus on its core activities in policy advocacy, market development and industry education and ensure that it supports its members and Australia’s financial markets in an optimal way. In May 2016, AFMA had announced its intention to step away from the function of being a benchmark administrator for this purpose – see AFMA Market Notice 2016_3.

New laws on bankers behaving badly don’t matter in light of ASIC inaction

From The Conversation.

The governmnent’s new laws to tackle manipulation of the bank bill swap rate may seem like a crackdown on badly behaving bank employees but in reality the Australian Securities and Investments Commission (ASIC) hasn’t used the full force of the law in the past to prosecute. So perhaps it’s time Australia followed the lead of the US and UK who are really using law to hold banks to account.

The bank bill swap rate (BBSW) is used to set rates on hundreds of trillions of dollars worth of transactions, including interest rates on credit cards, student loans and mortgages. Banks also use the swap rate to determine the cost of borrowing from one another.

Three of Australia’s big four banks, ANZ, Westpac and NAB were accused of manipulating this rate. These latest measures, which include civil and criminal liability for bankers found guilty, come six years after the scandal first broke.

ASIC takes too long to prosecute

ASIC has dragged its feet so spectacularly on prosecuting this rate rigging, misconduct affecting A$20 trillion worth of financial products. In respect to some of the alleged wrongdoing, the clock has run out, and ASIC is now no longer able to prosecute. Added to that, it was not ASIC that uncovered the BBSW scandal in the first place.

The information was first volunteered by BNP Paribas. And while ASIC’s colleagues in the UK have brought down fines in the billions of dollars against UBS, RBS and Barclays for similar offences, ASIC is yet to dock a dime from our titans of finance.

There have been plenty of legal avenues where ASIC could have pursued the banks. For example, under section 12.2 of the Schedule to The Criminal Code Act, 1995 which allows a court to hold a corporation criminally liable for the criminal misdeeds of its employees. I know of no cases where ASIC has sought to prosecute under this provision.

Another is section 11CA (2)(e) of the Banking Act, 1959. This would allow APRA to remove members of the Board of a bank, and appoint their own nominee, if that bank has demonstrated corporate governance failures. Since 1998 when that provision was enacted, APRA has used it a total of zero times.

It seems the regulators are scared to take on the big banks. For one thing they fear that a misstep could precipitate panic in the market, resulting in a bank run leading to a financial crisis. And if our regulators are ever in any danger of forgetting that, the Australian Bankers’ Association is quick to remind them..

How this differs to the US and UK

While Australian regulators have been taking their time, regulators in the UK have brought to trial and achieved convictions.

Regulators in the US have arrested, among others, British citizens, such as Mark Johnson, HSBC’s global head of foreign exchange and Stuart Scott, then head of FX trading in Europe, for manipulating rates while they were in transit in the US.

Deutsche Bank is staring down the barrel of a US$10 billion fine, in the US, for malpractices it allowed to take place in Russia. Banks in the UK and Switzerland have been fined billions of dollars by US authorities for rigging rates in countries other than the US. All that is required is for the US Department of Justice to detect a malpractice or a fraud that can be shown to have affected US investors.

Already there is legal action in the US in the form of a class action suit against our banks for BBSW rigging. This could garner unwanted attention from US authorities and that could be actual punishment for Australian bankers.

Add to that the possibility that Australian bankers may find themselves under arrest when they pass through the US at any stage in the next five years, and one starts to put into perspective just how badly our regulators have done their job. Ironically, it’s US, not Australian authorities that Australian banks need fear, because of allegations of dishonest rigging of an Australian market, all of which allegedly took place in Australia.

Author: Andrew Schmulow, Senior Lecturer (1 July 2016 onwards), University of Western Australia

New (Weak) BBSW Rules Arrive

Treasurer Morrison has released new rules around the setting of the critical market benchmarks like bank bill swap rate (BBSW), which set pricing for many financial products. The rules cover how the BBSW is set and how the rate setting mechanism will be administered and licensed. However, the banks though still run the show. We think there is a case of an independent reference rate. And is the timing convenient, ahead of the banks appearance before the economic committee this week, to defuse the BBSW issue?

The Australian Securities and Investments Commission (ASIC) is already pursuing three of the four major Australian banks over unconscionable conduct and market manipulation in setting the BBSW from 2010 to 2012.

Morrison took recommendations have been jointly developed by the Australian Securities and Investments Commission (ASIC), the Reserve Bank of Australia, the Australian Prudential Regulation Authority and the Commonwealth Treasury aka the Council of Financial Regulators (CFR).

To achieve the objectives outlined above, the CFR broadly recommends that:

significant benchmarks (broadly, systemically important benchmarks and those that will have a significant impact on investors) be covered by the regulatory regime;
significant benchmarks be identified in a publicly accessible list that can be amended;
administrators of significant benchmarks be required to hold a new, standalone, ‘benchmark administration licence’ unless granted an exemption, and the licence be supported by ASIC powers to write rules imposing obligations;
an ‘opt-in’ mechanism be created to allow administrators of non-significant financial benchmarks to apply to be licensed if they meet licensing requirements and doing so has value;
submitters to regulated benchmarks be required to comply with ASIC rules on regulatory matters related to benchmark submission, with benchmark administrators having primary responsibility for the operation of the benchmark;
ASIC be given the power to write rules to compel submission to a significant benchmark as a last resort when necessary to support market functioning;
the manipulation of any financial benchmark (significant or non-significant) be made a specific criminal and civil offence; and Bank Accepted Bills and Negotiable Certificates of Deposit be expressly made financial products for the purposes of the offence provisions of Chapter 7 of the Corporations Act 2001.

So, the banks still maintain control of the BBSW. These changes are really pretty weak.

The Problem With Reference Benchmark Rates

A host of factors have put critical financial market benchmark rates such as LIBOR or BBSW under the spotlight. Can we trust them? It has been suggested that some banks have been rate rigging – for example in Australia, ASIC has commenced proceedings against some of our largest banks and there is debate about an alternative and more robust benchmark. So, an interesting speech by FED Governor Jerome H. Powell at the Roundtable on the Interim Report of the Alternative Reference Rates Committee sponsored by the Federal Reserve Board and the Federal Reserve Bank of New York looking at LIBOR is highly relevant. They just issued an interim report which shows that US Dollar Interest Rate Derivatives account for about US$200 trillion, with more than half in interest rate swaps, so small tweaks to the benchmark rate can yield big profits to the industry.

I want to thank the Alternative Reference Rates Committee (ARRC) for all its work in developing its interim report. This report marks a new stage in reference rate reform.¹ Reference benchmarks are a key part of the financial infrastructure. About $300 trillion dollars in contracts reference LIBOR alone. But benchmarks were not given much consideration prior to the recent scandals involving attempts to manipulate them. Since then, the official sector has thought seriously about financial benchmarks, conducting a number of investigations into charges of manipulation, publishing the International Organization of Securities Commission’s (IOSCO) Principles for Financial Benchmarks and, through the Financial Stability Board (FSB), sponsoring major reform efforts of both interest rate and foreign exchange benchmarks.² The institutions represented on the ARRC have also had to think seriously about these issues as they have developed this interim report. Now, we need end users to begin to think more seriously about how they use benchmarks and the risks they are taking on by relying so heavily on a reference rate–in this case U.S. dollar LIBOR–that is less resilient than it needs to be.

In saying this, I want to make it clear that LIBOR has been significantly improved. ICE Benchmark Administration is in the process of making important changes to its methodology, and submissions to LIBOR are now regulated by the United Kingdom’s Financial Conduct Authority. However, the term money market borrowing by banks that underlies U.S. dollar LIBOR has experienced a secular decline. As a result, the majority of U.S. dollar LIBOR submissions must still rely on expert judgement, and even those submissions that are transaction-based may be based on relatively few actual trades. This calls into question whether LIBOR can ultimately satisfy IOSCO Principle 7 regarding data sufficiency, which requires that a benchmark be based on an active market. That Principle is a particularly important one, as it is difficult to ask banks to submit rates at which they believe they could borrow on a daily basis if they do not actually borrow very often.

That basic fact poses the risk that LIBOR could eventually be forced to stop publication entirely. Ongoing regulatory reforms and changing market structures raise questions about whether the transactions underlying LIBOR will become even scarcer in the future, particularly in periods of stress, and banks might feel little incentive to contribute to U.S. dollar LIBOR panels if transactions become less frequent. Market participants are not used to thinking about this possibility, but benchmarks sometimes come to a halt. The sudden cessation of a benchmark as heavily used as LIBOR would present significant systemic risks. It could entail substantial losses and would create substantial uncertainty, potential legal challenges, and payments disruptions for the market participants that have relied on LIBOR. These disruptions would be even greater if there were no viable alternative to U.S. dollar LIBOR that market participants could quickly move to.

These concerns led the FSB and Financial Stability Oversight Council to call for the promotion of alternatives to LIBOR, and led the Federal Reserve to convene the ARRC in cooperation with the U.S. Treasury Department, U.S. Commodity Futures Trading Commission, and Office of Financial Research. LIBOR is currently the dominant reference rate in the market because of its liquidity. We are not under any illusions that moving a significant portion of trading to an alternative rate will be simple or easy. But I believe the ARRC has provided a workable and credible plan for creating liquidity in a new rate and beginning the process of moving trading to it.

We need input from end users and others to finalize the ARRC’s plans, and I look forward to hearing the views of those in attendance. Successful implementation will require a coordinated effort from a broad set of market participants. This effort will certainly entail costs, but continued reliance on U.S. dollar LIBOR on the current scale could entail much higher costs if unsecured short-term borrowing declines further and submitting banks choose to leave the LIBOR panels, especially if there were no viable alternative rate. Simply put, this effort is something that needs to happen, and if the ARRC members, the official sector, and end users and other market participants all jointly coordinate in finalizing these plans, then a successful transition can be made with the least disruption to the market, leaving everyone in a better place.

1. See Alternative Reference Rates Committee (2016), Interim Report and Consultation (PDF) Leaving the Board (New York: ARRC, May).

2. For more information on the IOSCO principles, see Board of the International Organization of Securities Commissions (2013), Principles for Financial Benchmarks: Final Report (PDF) Leaving the Board (Madrid: IOSCO, July).

ASIC commences civil penalty proceedings against National Australia Bank for BBSW conduct

ASIC has today commenced legal proceedings in the Federal Court in Melbourne against National Australia Bank (NAB) for unconscionable conduct and market manipulation in relation to NAB’s involvement in setting the bank bill swap reference rate (BBSW) in the period 8 June 2010 to 24 December 2012.

The BBSW is the primary interest rate benchmark used in Australian financial markets, administered by the Australian Financial Markets Association (AFMA). On 27 September 2013, AFMA changed the method by which the BBSW is calculated. The conduct that the proceedings relate to occurred before the change in methodology.

It is alleged that NAB traded in a manner that was unconscionable and intended to create an artificial price for bank bills on 50 occasions during the period of 8 June 2010 and 24 December 2012.

ASIC alleges that on these days NAB had a large number of products which were priced or valued off BBSW and that it traded in the bank bill market with the intention of moving the BBSW higher or lower. ASIC alleges that NAB was seeking to maximise its profit or minimise its loss to the detriment of those holding opposite positions to NAB’s.

ASIC is seeking declarations that NAB contravened s12CA, s12CB, the former s12CC, s12DA, s12DB and s12DF of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act), s912A(1), s1041A and s1041H of the Corporations Act 2001 (Cth) (Corporations Act).

Further, ASIC has sought from the court pecuniary penalties against NAB and an order requiring NAB to implement a compliance program.

ASIC will be making no further comment at this time.

National Australia Bank Group Chief Risk Officer David Gall today issued the following statement:

“Trust in the integrity of our financial markets is crucial to a strong Australian economy. A fair, well-functioning and competitive financial system is crucial to providing the best outcome for customers and the wider community.

“NAB takes its role in upholding high standards of professional conduct seriously. We are committed to service, integrity and ethics and our values reflect this.

“Following an industry-wide review by the Australian Securities and Investments Commission into participants in the Bank Bill Swap Rate (BBSW) market, ASIC has today filed a claim against NAB making a number of allegations including market manipulation and unconscionable conduct.

“These allegations relate to trading in the BBSW market during the period 8 June 2010 to 24 December 2012.

“NAB has fully co-operated with ASIC’s review and takes these allegations seriously. We do not agree with ASIC’s claims which means they will now be settled by a court process.

“As part of ASIC’s investigation NAB has provided emails, instant chat messages and telephone conversations involving our employees. NAB retains this information as part of our business processes.

“We remain committed to serving our customers and ensuring our people demonstrate the values and behaviours the community expects of us.

“As this matter is now before the court, it is not appropriate to comment further,” Mr Gall said.

Background

On 4 March 2016, ASIC commenced legal proceedings in the Federal Court against the Australia and New Zealand Banking Group Limited (ANZ) (refer: 16-060MR).

On 5 April 2016, , ASIC commenced legal proceedings in the Federal Court against the Westpac Banking Corporation (Westpac) (refer: 16-110MR)

Prior to filing against ANZ and Westpac, ASIC’s investigations into misconduct in the BBSW has seen ASIC accept enforceable undertakings from UBS-AG, BNP Paribas and the Royal Bank of Scotland (refer: 13-366MR, 14-014MR, 14-169MR). The institutions also made voluntary contributions totaling $3.6 million to fund independent financial literacy projects in Australia.

In July 2015, ASIC published Report 440, which addresses the potential manipulation of financial benchmarks and related conduct issues.

ASIC commences civil penalty proceedings against Westpac for BBSW conduct

ASIC says it has today commenced legal proceedings in the Federal Court in Melbourne against Westpac Banking Corporation (Westpac) for unconscionable conduct and market manipulation in relation to Westpac’s involvement in setting the bank bill swap reference rate (BBSW) in the period 6 April 2010 and 6 June 2012.

The BBSW is the primary interest rate benchmark used in Australian financial markets, administered by the Australian Financial Markets Association (AFMA). On 27 September 2013, AFMA changed the method by which the BBSW is calculated. The conduct that the proceedings relate to occurred before the change in methodology.

It is alleged that Westpac traded in a manner intended to create an artificial price for bank bills on 16 occasions during the period of 6 April 2010 and 6 June 2012.

ASIC alleges that on these days Westpac had a large number of products which were priced or valued off BBSW and that it traded in the bank bill market with the intention of moving the BBSW higher or lower. ASIC alleges that Westpac was seeking to maximise its profit or minimise its loss to the detriment of those holding opposite positions to Westpac’s.

ASIC is seeking declarations that Westpac contravened s.12CA, s.12CB and the former s.12CC of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act), s.912A(1), s.1041A of the Corporations Act 2001 (Cth) (Corporations Act).

Further, ASIC has sought from the court pecuniary penalties against Westpac and an order requiring Westpac to implement a compliance program.

ASIC will be making no further comment at this time.

Background

On 4 March 2016, ASIC commenced legal proceedings in the Federal Court against the Australia and New Zealand Banking Group (ANZ) (refer: 16-060MR).

Prior to filing against ANZ, ASIC’s investigations into misconduct in the BBSW has seen ASIC accept enforceable undertakings from UBS-AG, BNP Paribas and the Royal Bank of Scotland (refer: 13-366MR, 14-014MR, 14-169MR). The institutions also made voluntary contributions totalling $3.6 million to fund independent financial literacy projects in Australia.

In July 2015, ASIC published Report 440, which addresses the potential manipulation of financial benchmarks and related conduct issues.

ASIC commences civil penalty proceedings against ANZ for BBSW conduct

ASIC has today commenced legal proceedings in the Federal Court in Melbourne against the Australia and New Zealand Banking Group Limited (ANZ) for unconscionable conduct and market manipulation in relation to the ANZ’s involvement in setting the bank bill swap reference rate (BBSW) in the period March 2010 to May 2012.

The BBSW is the primary interest rate benchmark used in Australian financial markets, administered by the Australian Financial Markets Association (AFMA). On 27 September 2013, AFMA changed the method by which the BBSW is calculated. The conduct that the proceedings relate to occurred before the change in methodology.

It is alleged that ANZ traded in a manner intended to create an artificial price for bank bills on 44 separate days during the period of 9 March 2010 to 25 May 2012.

ASIC alleges that on these days ANZ had a large number of products which were priced or valued off BBSW and that it traded in the bank bill market with the intention of moving the BBSW higher or lower. ASIC alleges that ANZ was seeking to maximise its profit or minimise its loss to the detriment of those holding opposite positions to ANZ’s.

ASIC is seeking declarations that ANZ contravened s.12CA, s.12CB and the former s.12CC of the Australian Securities and Investments Commission Act 2001 (Cth), s.1041A of the Corporations Act 2001 (Cth) (Corporations Act), and s.912A of the Corporations Act.

Further, ASIC has sought from the court pecuniary penalties against ANZ and an order requiring ANZ to implement a compliance program.

ANZ in turn today rejected allegations regarding bank trading and the bank bill swap rate (BBSW) made in this afternoon’s statement of claim by the Australian Securities and Investments Commission (ASIC).

ANZ will vigorously defend legal action brought by ASIC. Since mid-2012 ASIC has been investigating the practices of 14 panel bank participants in the Australian interbank BBSW market covering the period 2007 to 2012. ASIC’s statement of claim in relation to ANZ covers to the period March 2010 to May 2012.

ASIC has advised ANZ that it has no concerns about the bank’s current market practices and ANZ notes there has been no allegation of collusion between it and other institutions. ANZ Chief Risk Officer Nigel Williams said: “We have cooperated fully with ASIC’s investigation over many months, at a cost of many millions of dollars. This includes actively seeking to resolve the Commission’s concerns since January 2015. “We believe the Commission’s statement of claim is based on a misunderstanding of how bank bill issuance and interest rate risk management operates and the limited case law which applies to this area. “Our practices in the BBSW market were consistent with Australian market practices in wholesale financial markets and we reject ASIC’s characterisation of the transactions in question.

“Chat messages between traders is an issue that we will continue to review. We have already dealt with chats and behaviours that breach our Code of Conduct through internal disciplinary action against the individuals involved. “Since June 2014 we have also engaged ASIC about chat messages between ANZ traders. We do not agree however with ASIC’s characterisation of the issues related to the chat messages. It is now for the Courts to provide clarity on trading practices,” Mr Williams said.

ASIC’s legal action is likely to take a considerable time to reach a resolution through the Courts and the matter of penalties is uncertain.

Is It Time For A Risk-Free Interest Rate Benchmark In Australia?

The principal interest rate benchmark in Australia is the bank bill swap rate (BBSW), but there are questions about its accuracy (and we know overseas, other benchmark rates – such as LIBOR – have been rigged). So Guy Debelle RBA Assistant Governor (Financial Markets) spoke at the KangaNews Debt Capital Markets Summit and both discussed domestic reforms around the benchmark, and mentioned the possibility of introducing a ‘risk-free’ interest rate for the domestic market, as a complement to BBSW. He did not talk about the investigations that ASIC is currently undertaking into conduct around BBSW.

Given its wide usage, BBSW has been identified by ASIC as a financial benchmark of systemic importance in our market. It is important there is ongoing confidence in it. Without that, we have a serious problem, given its integral role in the infrastructure of domestic financial markets.

As you may know, BBSW was calculated for a number of years by, each day, asking a panel of banks to submit their assessment of where the market was trading in Prime Bank paper at a particular time of the day. While it was a calculation based on submissions, it differed from LIBOR in that BBSW submitters were asked about where the market for generic Prime Bank paper was trading that day. In contrast, LIBOR submitters were asked about where they thought their own bank’s cost of funds was that day.

In response to the prospect of a large number of the participants on the submission panel no longer being willing to provide submissions, the calculation of BBSW was reformed in 2013 in line with the IOSCO Principles for Financial Benchmarks, which were issued in July 2013.

Since 2013, the Australian Financial Markets Association (AFMA) has calculated BBSW benchmark rates as the midpoint of the (nationally) observed best bid and best offer (NBBO) for Prime Bank Eligible Securities, which are bank accepted bills and negotiable certificates of deposit (NCDs). Currently, the Prime Banks are the four major Australian banks. The rate set process uses live and executable bid and offer prices sourced from interbank trading platforms approved by AFMA, These platforms are currently ICAP, Tullett Prebon and Yieldbroker. The bids and offers are sourced at three points in time around 10.00 am each day.

Trading activity during the daily BBSW rate set has declined over recent years to very low levels. There are quite a number of days where there is no turnover at all at the rate set. The low turnover in the interbank market raises the risk that market participants may at some point be less willing to use BBSW as a benchmark. This is the motivation for the CFR’s consultation to ensure that BBSW remains a trusted, reliable and robust financial benchmark.

The likely key change to the methodology proposed is to calculate BBSW directly from market transactions – that is, calculating BBSW as the volume-weighted average price (VWAP) of market transactions during the rate set window. Given the objective is to better anchor BBSW to transactions in the underlying market, the RBA supports moving the calculation methodology to the VWAP.

With regards to the risk-free benchmark:

Next I would like to briefly raise some issues around whether the use of BBSW needs to be quite as widespread as it is. In a number of instances, BBSW has become the default reference rate without much thought being given as to whether it is the most appropriate reference rate. BBSW is a credit‑based reference rate. It is based on the borrowing costs of the major banks, with the credit risk that entails embodied in the rate.

For a number of purposes, a credit‑based rate is completely appropriate. However, for other purposes, a rate that is closer to risk‑free may be more appropriate. For instance, in recent years, market participants have moved to use overnight-indexed swap (OIS) rates more often when discounting the cash flows in their swaps. The FSB, through its official sector steering group (OSSG) on benchmark reform, is encouraging market participants to contemplate switching from credit‑based benchmark rates like BBSW or LIBOR to risk‑free rates, where appropriate.

In the local market, there appears to be growing interest in using risk-free rates as benchmarks. Such a rate could be backward looking, like the cash rate, or forward looking, like OIS rates. As a first step, some market participants have indicated that a total return index of the cash rate would be a useful backward-looking benchmark. Implementing this would be straightforward, since the RBA already calculates and publishes the cash rate. Some market participants are also interested in referencing a forward-looking rate with equivalent tenors to BBSW, and we will continue to work with AFMA on the development of such a benchmark.

One example where a change in reference rate could be contemplated is for floating rate notes (FRNs) issued by governments. FRN coupon payments are typically priced at a spread to BBSW. While referencing BBSW makes sense for FRNs issued by banks, it is less clear why governments should tie their coupon payments to a measure of bank funding costs.

That is one example worthy of consideration. There are a number of others. I know this is not necessarily an issue you may have thought that much about until now. At the very least, I would encourage you to at least ask the question whether the product you are issuing or holding is using the most appropriate reference rate.

Can We Trust The BBSW?

RBA’s Guy Debelle, Assistant Governor (Financial Markets) has been speaking about benchmark currency and interest rates. Benchmarks only work if they are trusted, and transparent. Of note are his comments on the local market, where the primary interest rate benchmark is the bank bill swap rate (BBSW).

As you may be aware, a few weeks ago, the Council of Financial Regulators issued a consultation paper on possible reforms to BBSW. I will run through the motivation for doing so as well as the possible options we canvassed in the consultation paper.

Given its wide usage, BBSW has been identified by ASIC as a financial benchmark of systemic importance in our market. Hence it is important there is ongoing confidence in it.

As you may know, BBSW was calculated for a number of years by, each day, asking a panel of banks to submit their assessment of where the market was trading in Prime Bank paper at a particular time of the day. While it was a submission-based process, it was different from LIBOR in that it was the assessment of the borrowing cost of a notional Prime Bank, informed by observable transactions, rather than an assessment of a submitting bank’s own borrowing costs.

In response to the prospect of a large number of the banks on the submission panel no longer being willing to provide submissions, the calculation of BBSW was reformed in 2013 in line with the International Organization of Securities Commissions’ (IOSCO) Principles for Financial Benchmarks, which were issued in July 2013.

Since 2013, the Australian Financial Markets Association (AFMA) calculates BBSW benchmark rates as the midpoint of the nationally observed best bid and best offer (NBBO) for Prime Bank Eligible Securities, which are bank accepted bills and negotiable certificates of deposit (NCDs). Currently, the prime banks are the four major Australian banks. The rate set process uses live and executable bid and offer prices sourced from interbank trading venues approved by AFMA, which are currently ICAP, Tullett Prebon and Yieldbroker. The bids and offers are sourced from three times around 10am each day.

While the outstanding stock of bills and NCDs issued by the Prime Banks has increased since 2013 to around $140 billion, trading activity during the daily BBSW rate set has declined over recent years. The consultation paper illustrates how low the turnover currently is. There are quite a number of days were there is no turnover at all at the rate set. The low turnover in the interbank market raises the risk that market participants may at some point be less willing to use BBSW.

This is the motivation for the CFR’s consultation to ensure that BBSW remains a trusted, reliable and robust financial benchmark.

Some preliminary data collected from the four major Australian banks indicate that there is substantially more activity in the NCD market than is being measured at the rate set, with the activity mainly occurring outside the interbank market. At least $100 million in NCDs were bought or sold on almost all business days, with activity almost entirely at the 1-, 3- and 6- month tenors. However, the non-bank participants that buy and sell NCDs tend to transact bilaterally with the issuing bank, with the price struck at the (yet to be determined) BBSW ahead of the actual rate set, rather than at a directly negotiated rate. If these participants could be encouraged to buy and sell NCDs at outright yields, then these transactions may have the potential to underpin the BBSW benchmark.

Hence the consultation paper proposes one option for reform which would be to continue with the current NBBO calculation methodology, but to underpin the executable prices with a broader set of NCD market transactions contracted up to the time of the rate set. By more firmly anchoring the BBSW benchmark to observable transactions entered into at arm’s length between buyers and sellers in the market, this may ensure that the benchmark remains a credible indicator of rates in the market.

For this option to be feasible, it would be necessary for the banks to directly negotiate the interest rates on their NCDs with third parties, rather than linking the rate to BBSW. This would require a change to the existing market practice. (In this regard this option has some similarities with the FX benchmark reforms where prior to the reforms, participants also agreed to transact at a yet to be determined price and at the midpoint of the fix.)

Another option for reform, akin to the proposed methodology for LIBOR, would be for the banks to submit to the benchmark administrator their assessment of their aggregate cost of wholesale funding, based on their transactions in a particular window. That is, the banks would do the aggregation and the administrator would only need to average the (currently) four submissions. An alternative option would be for the banks to submit all their transactional data to the benchmark administrator who would then itself do the aggregation. Both of these options would need to provide for circumstances in which the Prime Banks had not executed any transactions in the relevant window.

The final option would be to accept the current system as it is, notwithstanding the very low turnover at the rate set.

The consultation is open until 3 December.