BBSW

BBSW is the interbank reference interest rate for Australia.

It stands for "Bank Bill Swap Reference Rate", for which it is the acronym: B(ank) B(ill) SW(ap)

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 ASIC (Australian Securities and Investments Commission - see section on Australian Financial Regulation) 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 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 is 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.

BBSW calculation methodology evolution:

1. 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 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 ANZ, Westpac and NAB over rate rigging pre 2013 - and shortly after, a US class action ensued against these and several other banks. As at February 2017, these court cases were unresolved. Pre 2013: the annual re-election of Prime Banks was also instigated; 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. Thus, in 2013, the calculation methodology was reformed in line with IOSCO (International Organisation of Securities Commissions) principles, so live, executable inter-bank rates for "Prime Bank" "eligible securities" were sampled at three random intervals during a daily trading window at or around 10 am at "Approved Trading Venues" (ATVs). The highest and lowest rates were ignored and then an average was taken to form the BBSW rate for that tenor. This process is known as "NBBO" - "Nationally observed Best Bid and Offer rate" and as at February 2017, continues to be the methodology used.

3. However, in October 2015, the "CFR" (Council of Financial Regulators), 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 may 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, AFMA issued a discussion paper in February 2016, with proposed possible methodology changes. It is known that this new methodology will be based on a "Volume Weighted Average Price" method and that NBBO will be a back up method. It is likely that: the underlying eligible securities will be broadened to include those traded by non-banks (e.g. Investment Funds and Treasury Corporations) - however, they will still be the NCDs and BABs of Prime Banks; that 2, 4 and 5 month maturities will be interpolated from 1, 3 & 6 month rates; that a mix of telephonic and electronic trading prices will be used; and the rate set window will be extended to cover 9am to 10.10am. The change 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.

As at February 2017, the exact new methodology and its "go-live" date have yet to be fully published, but should occur during 2017.

Whilst AFMA own the methodology, the administration and publication of BBSW have been passed to the ASX (Australian Securities Exchange), as from 1st January 2017, after a tender process. There will be a transition window to June 2017. Going forward, AFMA will support the future evolution of BBSW by working with 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 Terms:

"Prime Banks" are those that meet eligibility criteria set by AFMA (Australian Financial Markets Association - an Industry body, rather than a regulatory body) - in February 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. Currently, NCDs form 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 February 2017.