BBSW calculation methodology
BBSW (Bank Bill Swap Reference Rate) is the interbank reference interest rate for Australia.
BBSW calculation methodology evolution
The methodology used to calculate BBSW has evolved over the years.
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 the Australian Securities and Investment Commission (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 VWAP method (with NBBO as a back up) was selected. The transition to VWAP has been a significant exercise as it required the development of new market infrastructure and a change in the way that a significant part of the market operates.
Whilst AFMA own the methodology, the administration and publication of BBSW were passed to the Australian Securities Exchange (ASX), on 1 January 2017. The ASX have continued to use the NBBO methodology but have gradually transitioned to the VWAP methodology in 2018, with go-live of the new BBSW VWAP methodology on 18 May 2018, as long as a parallel run that started on 26 March 2018 is successful.
In support of the new methodology, the Australian Securities Exchange (ASX) in consultation with regulators and market participants, has developed the BBSW Trade and Trade Reporting Guidelines. These are designed to provide clarity to participants on market practices to be followed when trading Bills and NCDs, to define trade reporting for the purpose of calculating a BBSW rate based on actual transactions and to meet regulatory requirements for Benchmark Administrators.
Going forward, AFMA will support 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 (see Australian Financial Regulation).
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
- ANZ
- ASX
- Australia
- Australian Financial Regulation
- BBSW
- International Organization of Securities Commissions
- LIBOR
- Prime bank
- Reference rate
- SIBOR
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
