BBSW

Australia

Bank Bill Swap Reference Rate (from: B(ank) B(ill) SW(ap)).

BBSW is the interbank reference interest rate for Australia.

It is Australia's equivalent of LIBOR or SIBOR, in that it is a reference rate that is referred to in many loan and derivative contracts, for which it will act as the base interest rate, before a margin is applied.

Given its wide usage, BBSW has been identified by the Australian Securities and Investments Commission (ASIC) as a financial benchmark of systemic importance to Australian financial markets and it is therefore important to anyone with an exposure to Australia, that there is ongoing confidence in it.

BBSW calculation

BBSW is a mid rate and its calculation methodology has evolved over the years.

It is calculated and published daily (at 10.15am Australian Eastern Time zone) and is available for the tenors of 1, 2, 3, 4, 5 & 6 months.

BBSY (Bank Bill Swap bid rate) is calculated from the BBSW rate +/- 5 basis points, which derives the BID and ASK rates.

Both rates are available on Reuters under these acronyms.

Being the inter-bank rate, BBSW does contain bank credit risk.

Calculation methodology evolution

1. Pre 2013

Pre 2013, the BBSW calculation methodology involved '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. But, it was suspected this was being abused and panel banks became unwilling to provide submissions any longer.

Investigations were undertaken and in the cases of international banks RBS, UBS and BNP, the banks themselves found that 'rigging' may have been undertaken, so made voluntary donations to ASIC (between A$1m & A$1.6m each).

In June 2016, ASIC announced it was suing Australian financial institutions ANZ, Westpac and NAB over rate rigging pre 2013 - and shortly after, a US class action ensued against these and several other banks (see Notes below).

Pre 2013:

• the annual re-election of Prime Banks was also instigated;

• the collation and publication of 9 & 12-month BBSW rates was discontinued due to consistency challenges; and

• the BBSW Committee composition was revised to include buy-side and broker representation.

2. 2013 reforms

Thus, in 2013, the calculation methodology was reformed in line with International Organization of Securities Commissions (IOSCO) principles:

• Live, executable inter-bank rates for 'Prime Bank eligible securities' sampled at three random intervals during a daily trading window at or around 10am at Approved Trading Venues (ATVs).

• The highest and lowest rates ignored and then an average taken to form the BBSW rate for that tenor.

This process is known as NBBO - 'Nationally observed Best Bid and Offer rate'.

3. Further reforms

In October 2015, the Council of Financial Regulators (CFR), initiated a consultation process that invited responses to a proposed evolution of the BBSW calculation methodology, to ensure it remained a trusted and relevant benchmark.

This was driven by a fall to significantly low levels in trading of Prime Bank eligible securities during the BBSW sampling window, which raised the risk that market participants might at some point be unwilling to use BBSW as a benchmark.

Causes of this trend were:

a) a shift in NCD trading from banks to non-banks;

b) a reluctance by institutions to trade during the rate set window due to the conflict of interest caused by being part of a rate set process and then using the same rate in the derivatives market - and their uncertainty with how regulators would react;

c) money market funds wanting to trade at BBSW (as their performance is benchmarked to this) and not to be part of the rate set process;

d) foreign bank branches having less demand for NCDs and BABs than in the past since they are not considered high-quality liquid assets under the Liquidity Coverage Ratio (part of Basel 3).

Having received numerous responses, the Australian Financial Markets Association (AFMA) issued a discussion paper in 2016, with proposed possible methodology changes.

These included a 'Volume Weighted Average Price' method (VWAP) with NBBO as a back up method.

The discussion paper also proposed:

• Broadening the underlying eligible securities to include those traded by non-banks (e.g. Investment Funds and Treasury Corporations) - however, they would still be the NCDs and BABs of Prime Banks;

• Interpolating 2, 4 and 5-month maturities from 1, 3 & 6-month rates;

• Using a mix of telephonic and electronic trading prices; and

• Extending the rate set window to cover 9am to 10.10am.

The transition to the VWAP methodology is a significant exercise as it requires the development of new market infrastructure and a change in the way that a significant part of the market operates.

The exact new methodology and its 'go-live' date were scheduled for publication in 2017.

Whilst AFMA own the methodology, the administration and publication of BBSW were passed to the Australian Securities Exchange (ASX), on 1 January 2017, after a tender process, with a transition window to June 2017.

Going forward, AFMA supported the future evolution of BBSW by working with the 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.

Glossary of BBSW terms

Prime Banks are those that meet eligibility criteria set by AFMA in early 2017, these were the four main banks of Australia: NAB, Westpac, ANZ and CBA - but a greater range of banks have constituted the Prime Bank panel in the past.

Eligible Securities are Negotiable Certificates of Deposit (NCDs) and Bank Accepted Bills (BABs) of Prime Banks.

In early 2017, NCDs formed about 85% of eligible securities, with BABs forming the balance.

They are seen as a homogenous asset class that promotes market liquidity and provides the basis for effective price discovery in the market.

NCDs and BABs form a key part of the range of instruments through which banks manage their liquidity.

Approved Trading Venues - where the trade in eligible securities occurs - ICAP, Tullett Prebon and Yieldbroker, as at early 2017.

See also

• ASX
• Australia
• Australian Financial Regulation
• International Organization of Securities Commissions
• LIBOR
• Prime bank
• Reference rate

Notes

ASIC sues NAB, ANZ and Westpac

ASIC press release - 7 June 2016

ASIC press release - 5 April 2016

ASIC press release - 4 March 2016

US class action

News report - 18 August 2016