Debelle demands action on rates swap

Ian Rogers Latest news
Guy Debelle (left) with RBA colleagues   (AAPIMAGE)
Guy Debelle (left) with RBA colleagues (AAPIMAGE)

There's an avalanche of florid topics harassing the banking industry and RBA deputy governor Guy Debelle yesterday dragged readiness for interest rate benchmark reform to the forefront.

Debelle's coda to his speech to the Annual Risk Australia Conference in Sydney yesterday aired a new policy that will affect most banks and their treasury's daily dealings with the Reserve Bank's market operations.

His topic was one on which he and Christopher Kent, the head of financial markets at the Reserve Bank, have cautioned the industry around 20 times over the last two years.

"The end of LIBOR is not a risk. It's a certainty that the finance industry needs to be ready for," Debelle declared.

"It has now been just over two years since Andrew Bailey announced that the UK's Financial Conduct Authority would no longer use its powers to sustain LIBOR beyond 2021.

"Financial regulators around the world expect institutions using LIBOR to be ready to transition to more robust benchmarks. With strong support from the RBA and APRA, ASIC recently wrote to the CEOs of major Australian financial institutions to seek assurance that they are taking appropriate action.

"The transition from LIBOR to alternative risk-free rates (RFRs) is accelerating internationally. Usage of risk-free rates in derivatives markets is increasing, and they are being adopted in some cash products.

"There has also been good progress on developing more robust fall-back provisions in contracts referencing LIBOR" he said.

"ISDA has completed consultations on the fall-back methodology for almost all of the LIBOR currencies (and some other IBORs including BBSW," in Australia).

For the fall-back risk-free rate, Debelle explained that ISDA "found strong support" for using the following formula:

"The compounded RFR with an adjustment for the historical spread between the RFR and LIBOR."

Once ISDA has finalised the fall-back provisions, "[global] regulators expect users of benchmarks to adopt them," Debelle said, reprising a line from his speech to the KangaNews DCM Summit five months ago.

In Australia though, the RBA's deputy explained "have taken a different path.

"The credit-based benchmark BBSW (the Bank Bill Swap Rate) has been strengthened and coexists alongside the cash rate, which is the risk-free rate for the Australian dollar. This has been possible since both BBSW and the cash rate are supported by underlying markets with enough transactions to calculate robust benchmarks."

At the beginning of 2017, the ASX became administrator of the Bank Bill Swap rate previously produced by the Australian Financial Markets Association.

"We have been encouraging users of Australian dollar benchmarks to be choosing the benchmark that is most appropriate for their circumstances. Sometimes it makes sense to use a credit-based benchmark, such as BBSW, particularly when banks are issuing funding instruments.

"However, it often makes more sense to use a risk-free benchmark, such as when governments raise funding. There has been progress on this in recent months, with the South Australian Government Financing Authority issuing the first FRN referencing the cash rate," which more technically SAFA's did via reference to the Australian Overnight Index Average (AONIA).

SAFA were close to relying on AONIA in a bond issue in December last year but backed off.

Urging deep engagement, Debelle found "the lesson from LIBOR is that no benchmarks should be taken for granted.

"So while BBSW remains robust, it is prudent to have robust fallbacks in your contracts in case it were ever to cease. This is why we have been working with ISDA to strengthen the contractual fallbacks for BBSW too."

A snappier version of what Australia's central bank is looking for goes like this: "The RBA is encouraging market participants to reduce their use of the BBSW fixing and to transfer their contracts to more robust mechanisms," in the words of the Credit Suisse commentator Sean Keane of Triple T Consulting.

"Once ISDA has finalised the fall-back provisions, we expect all users of BBSW to adopt them where possible.

"The RBA will be managing our own risks in this area by requiring new securities referencing BBSW to have robust fall-back provisions in order to be eligible in the RBA's market operations," Debelle informed banks.