Time for issuers and investors to step up engagement on benchmark reform
End users can no longer ignore the domestic and international process of reforming benchmark rates, according to speakers at the International Swaps and Derivatives Association (ISDA)’s annual Australian conference in Sydney. The local market is less than halfway through its own transition and the main concern is lack of engagement from many issuers and investors.
Many global markets including the UK and US are preparing for the demise of interbank offered rates (IBORs) at the end of 2021. Australia is in the fortunate, though not unique, position of having a robust IBOR – bank-bill swap rate (BBSW) – that is expected to continue to exist. But market users close to the process of benchmark reform say local end users cannot afford to be complacent.
Specifically, Christopher Kent, assistant governor, financial markets at the Reserve Bank of Australia (RBA), told delegates at the ISDA event that Australian end users need to understand their exposures to IBORs – on and off balance sheet including hedging exposures – and make plans for the adoption of risk-free rates (RFRs).
RFR adoption includes exploring fallback provisions in contracts for the replacement of IBORs, including being covered for any future demise of BBSW, as well as reviewing operational processes and systems to ensure they can handle RFRs.
Commonwealth Bank of Australia’s group interest-rate benchmark reform lead, Pieter Bierkens, said: “It is critical that everyone be informed about what is going on. This is a risk-management issue around what the changing benchmark ecosystem means for exposures in future, and this includes potential implications for the future of benchmarks in Australia. The issue is not going away.”
Several speakers at the ISDA conference suggested that the level of engagement in the Australian issuer and investor community is patchy and in places clearly insufficient. Kent referred to letters the Australian Securities and Investments Commission has sent to chief executives asking for information on their organisations’ preparations for benchmark transition.
Responses to these letters should provide more detailed information on preparedness, Kent said. While final conclusions have not been drawn yet, he added: “The preliminary analysis of responses suggests there is quite a bit of difference in progress… The areas of concern are smaller organisations and the buy side, which may need external expertise in this area.”
Drew Bradford, executive general manager, markets at National Australia Bank (NAB), said it is time for a wider, coordinated effort. “No single firm can resolve the issues on its own – this is an industry-wide problem. Our clients, the end users, need to be aware of what is going on so they can make informed decisions about their own transition.”
Bradford echoed Kent’s view that there is a wide range of engagement in the end-user universe. He said some of NAB’s clients are actively managing transition, others are “nervous” but waiting for further guidance and some see the issue as similar to the Y2K bug – something that will probably turn out to be more noise than signal.
The latter view is no longer justifiable, and time may also be running out for the wait-and-see approach. Kent said: “The end of LIBOR is not a risk – it is a certainty. The risk is that people are not ready when it disappears at the end of 2021.”
Specifically, this means contracts that reference a defunct IBOR and have not been amended to transfer to a robust alternative reference rate becoming orphaned and potentially unenforceable. Kent said such contracts will inevitably be tied up in lengthy disputes after the demise of relevant IBORs, which he argued is a risk for the whole financial sector as well as the specific organisations involved.
Concern around wider engagement does not mean the Australian market has made no progress. Market leaders are already working on the basis that there is no room for complacency about BBSW. Helen Lofthouse, executive general manager, derivatives and OTC markets at the Australian Securities Exchange – which took over as BBSW administrator in 2018 – acknowledged that the existing rate will in future be just a part of the benchmark ecosystem.
“Work on benchmark fallbacks remains important even with BBSW continuing – because the international experience has demonstrated that things can change,” she explained. “We have to be aware that similar change could happen to BBSW, though hopefully only far in the future.”
Australia has settled on the RBA cash rate, expressed as the Australian overnight index average (AONIA), as its RFR. Meanwhile, as Kent pointed out, the big-four banks have all issued RFR-linked bonds in offshore markets while the South Australian Government Financing Authority (SAFA) brought the first AONIA-based deal to the local market in June.
Fiona Trigona, head of funding and balance sheet at New South Wales Treasury Corporation, said at the ISDA event that the SAFA deal has significance to market users beyond the issuer itself. “The fact that the investor base – thanks to SAFA – is actively looking at AONIA as a transaction benchmark is very important. We participated in the deal as an investor in part because we wanted to test our own operational ‘plumbing’.”
On the other hand, SAFA’s deal itself demonstrates that market users cannot afford to delay when it comes to RFR implementation. Andrew Kennedy, SAFA’s director, treasury services, told ISDA delegates the transaction had its genesis eight years prior to eventual execution.
“It certainly wasn’t something we decided to do a week before coming to market – it was a long and considered process,” Kennedy revealed. “My sense is that the market as a whole has only just scratched the surface of the benchmark issue.”
Bierkens agreed with this assessment. Noting that the clock for IBOR cessation was set in 2017 – meaning markets have used more than half the time allowed for transition – he suggested that most of the heavy lifting in Australia remains to be done and that the local market is not yet halfway through its own transition.
Forward-looking term rates
Some market participants believe the emergence of a forward-looking term RFR would be a significant boon to the transition drive. The idea is that such a rate would be a close substitute for existing IBORs and would thus significantly reduce the operational impact of transition.
There would also be a positive benefit for the real economy, as retrospective rate calculation based on compounded daily rates is likely to prove problematic for many payment systems.
Nick Burrough, market specialist at Bloomberg, explained: “A forward-looking RFR would be a godsend for a lot of smaller corporates. We have already seen, for example, 10 regional banks in the US stating that the secured overnight funding rate in its current state is not suitable for their lending books.”
As yet, however, no suitable forward-looking rate is available – and Kent was quick to recommend that market participants do not delay their own transition preparations in expectation of one’s arrival.
“It is possible to imagine a forward-looking rate being created from existing traded instruments, but the experience from BBSW suggests doing so would be a long, careful process,” he said. “Given the deadlines involved I don’t think there is time to develop these rates successfully before IBOR cessation.”
Bradford noted international experiences on forward-looking RFR development as a worthwhile comparison. While arguing that such a rate is “considered essential” in international jurisdictions, he revealed that no-one is hanging their hopes on delivery prior to IBOR cessation. The UK has an RFP in place for a forward-looking rate, but local issuance is already largely using the existing format of the sterling overnight index average. US regulators, meanwhile, have stated that market users should not wait for forward-looking RFRs.
“There is 800 days left until LIBOR ceases to exist and the next two years will clearly be challenging,” Bradford said. “Being prepared now is the best way of navigating those challenges.”
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