Benchmark reform
The demise of interbank offered rates globally looks set to be the latest major upheaval international capital markets will have to confront. Australian borrowers need to start preparing for a major shift in the years ahead.
STANLEY The end of LIBOR might seem a long time away right now, but with the amount of work that needs to be done I think market participants will have to start preparing sooner rather than later.
BROWN We are less convinced that BBSW will survive, even though the banks have said they want it to. The main reason is that there will be the secured overnight financing rate (SOFR), sterling overnight index average and other rates offshore which, for cross-currency basis swaps, need to be set against an Australian equivalent.
As soon as this Australian equivalent is created it could be used for anything. I suspect there would be strong pressure from offshore over time to use a risk-free rate. It’s hard to imagine a big US-based issuer like World Bank, which will be using a risk-free rate everywhere else in the world, wanting to issue against BBSW in Australian dollars.
WHETTON The RBA’s repo rate doesn’t have a curve and is extremely volatile, so employing it as a risk-free rate is pointless.
The big presumption with SOFR is that it is a risk-free rate, but even today we have been talking about the US losing its exorbitant privilege as the reserve currency. SOFR is a secured overnight rate so there isn’t a lot of risk to it, but it is more volatile than – unsecured – LIBOR and it presumes that US Treasury debt is all ok.
The end of LIBOR might seem a long time away right now, but with the amount of work that needs to be done I think market participants will have to start preparing sooner rather than later.
BROWN The regime change also draws a lot more risk into banks. Banks had almost an embarrassingly good position in that they could write loans linked to cost of funds. When the banks’ cost of funds went up, so did everyone else’s. The bank was perfectly hedged. It doesn’t work this way under the new system. If there were a step-change wider in spreads, banks would find it difficult to pass it on to loans.
WHETTON There will have to be risk management of a bank’s assets and liabilities. If you buy a bond or take a deposit you swap it all back to three-month floating-rate. The question is how the transition will be made. If we thought overnight-indexed swap discounting was difficult a few years ago, this will be immensely more difficult. No-one will be willing to be worse off.
BROWN We often hear from traders that it couldn’t possibly happen because it will cause mark-to-market losses. But there is a substantially different view from government. There is some complacency among market-makers that the government would never cause a mark-to-market loss.
