Remarks by Daniel Mminele,
Deputy Governor of the South African Reserve Bank,
at the annual Financial Markets Department cocktail function
Johannesburg
7 May 2019
Introduction
Good evening, ladies and gentlemen.
It is that time of the year when we have the pleasure of welcoming you to the Financial
Markets Department's (FMD) annual cocktail function. Thank you for joining us. When
we agreed the date for this function, we did not know that we would be meeting on the
eve of a rather crucial day for our country. Allow me to remind you that voting is an
important responsibility of citizenship.
This event allows the South African Reserve Bank (SARB), and specifically FMD, to
convey our appreciation for the working relationships we have developed with you, our
counterparties - whether it be through the execution of open market operations or by
engaging with you on the ever-increasing complexities of financial markets through
our regular meetings or access to your research. These engagements make an
important contribution to enriching our understanding of financial market
developments in support of the formulation and implementation of monetary policy and
financial stability policy. We also value that we get to network a little less formally at
this event than at our various official forums.
Allow me to take stock of what has again been a rather eventful year in international
and domestic financial markets since we last met for the annual cocktail function. And,
as it has now become tradition, I will also provide an update on some of FMD's key
initiatives, especially those that relate to financial market development and thus have
a direct bearing on your work. I will try to be brief, and heed the words of Josh Billings:
"There's a great power in words, if you don't hitch too many of them together."
The global financial markets backdrop
The past year has been characterised by a mixed environment for asset prices. The
significant shifts that we have observed were mainly influenced by both the adopted
and expected policy stances of major central banks. Initially, growing divergence
between the US economy and major trading partners, coupled with increasing trade
tensions and perceived higher geo-political risk, placed upward pressure on the US
dollar (USD). The USD had also found support from the US Federal Reserve (Fed)
continuing with its gradual path of monetary policy normalisation, while other major
central banks lagged behind by keeping policy rates constant. US equities also
outperformed their European and Japanese counterparts.
These developments resulted in emerging markets with relatively weak fundamentals,
compounded by spill over effects from developments in Argentina and Turkey, seeing
their currencies and financial assets coming under pressure, South Africa being no
exception. There was a discernible change in the final quarter of 2018 when
indications of slowing economic activity in the US (against the background of already
weak growth outside the US) led the market to anticipate a slower pace of Fed policy
tightening and some downward pressure on the USD. Concerns around a stronger
than anticipated slowdown in global growth, together with geo-political developments,
then led to a sharp increase in volatility and a correction in equity markets. The
Chicago Board Options Exchange Volatility Index rose to a nine-month high of 36
index points in late December, while the S&P 500 fell by 9.2% during the same month.
The MSCI All Country World Index, which includes both developed and emerging
markets, also ended up recording its worst year in a decade by posting an 11.2% loss
(although it has posted a 14% recovery year-to-date). Around the same period, yields
on 10-year bonds in the US and Germany declined, the latter to two-year lows as safe-
haven demand increased.
Turbulence in markets, alongside the expected fading effect of US fiscal stimulus, and
slower growth in the eurozone, contributed to the significant change in monetary policy
forward guidance given by the Fed and European Central Bank (ECB). This has
resulted in some easing in financial conditions and has been supportive of a rebound
in risk assets in recent months. The Fed has pledged to be patient in respect of any
further interest rate increases (with some market participants predicting the next move
to actually be a cut), and to adjust the pace of balance sheet normalisation, while the
ECB also changed course, delaying any previously envisaged interest rate
adjustments to 2020 and committing to offer banks a new round of cheap loans to help
revive the eurozone economy.
In addition, multilateral institutions have recently downgraded their economic growth
projections. The International Monetary Fund (IMF) has, in its latest World Economic
Outlook report1, pencilled in a 3.3% global growth forecast for this year, with an
expected pickup in 2020 predicated on Chinese stimulus measures, improved market
sentiment, dissipating temporary drags on euro-area growth, and stabilisation in
certain stressed emerging market economies.
However, there are still uncertainties which will keep policymakers and market
participants awake. Policy and political uncertainty will include geo-political
developments, a possible disorderly Brexit, escalating trade tensions, and a sudden
renewed tightening in financial conditions. The IMF has also flagged vulnerabilities
stemming from China's financial imbalances, volatile portfolio flows to emerging
markets and fiscal challenges in some highly indebted European countries. However,
the expectation overall, even with the generally limited policy space, seem to be for a
soft landing of the global economy rather than a recession.
Developments in domestic financial markets
Domestic financial markets have been influenced by a combination of global
developments and domestic idiosyncrasies. The local unit was not immune to the
broad sell-off in the emerging market foreign exchange (FX) complex, which began
last April and accelerated into September. The rand reached a 'peak' of R15.42
against the US dollar on 5 September 2018, while the nominal effective exchange rate
depreciated to an over two-year low of 53.81.
It is interesting to note that, despite the rand's depreciation of roughly 16% against the
US dollar since we last met, the sell-off in domestic bonds was not as pronounced
relative to the currency depreciation as was the case during previous periods of market
stress. The yield on the R186 bond has increased by approximately 24 basis points
since last April. Lower inflation outcomes have gone some way in capping the rise in
bond yields, underscoring the importance of central banks keeping inflation
expectations anchored. Moody's recent credit opinion, stating that it expects South
Africa's credit profile to remain in line with those of similar Baa3-rated sovereigns, has
also provided some relief to local bond markets. However, elevated government debt
and contingent liabilities related to state-owned enterprises, as well as persistently low
growth, are credit constraints. While the JSE All-Share Index looks relatively
unchanged to when we last met, this masks some volatility, with declines in the latter
half of 2018 and a subsequent recovery this year.
South Africa has not been immune to the volatility in flows to emerging markets. Non-
residents sold R112.4 billion worth of domestic equities since May last year, with
outflows of R27.5 billion reported on a calendar year-to-date basis. For bonds, net
non-resident outflows totalled R86.1 billion over the last year, although some stability
has returned with bond inflows of R26.3 billion since the start of this year.
In response to new developments and changing risks, monetary policy continued to
keep its focus on maintaining inflation comfortably within the target range and
anchoring inflation expectations closer to the 4.5% midpoint of the inflation target
band. It is a stable price environment which contributes towards broader
macroeconomic stability and protects the purchasing power of all South Africans.
While the MPC assessed the risks to the inflation outlook as more or less evenly
balanced, the most recent developments in relation to oil prices and the exchange
rate, along with other previously identified risks, such as electricity and water tariffs,
and food prices, show that vigilance and data dependency must remain the order of
the day.
As previously indicated, appropriate monetary policy settings need to be
complemented by prudent fiscal and budgetary policies to help raise potential growth
and lower the cost structure of the economy.
Key domestic initiatives
Let me now touch on some initiatives undertaken by the SARB to strengthen domestic
financial markets.
Firstly, I would like to make a few remarks on the reform of the major interest rate
benchmarks, which needs to be framed in the context of global developments. Many
of you will know by now of the work to reform interbank offered rates, collectively
referred to as 'IBORs'. For the major IBORs, reform efforts have focused on
strengthening their resilience and reliability, including ensuring that they are
underpinned by transaction data to the greatest extent possible. But what is perhaps
most pertinent is the looming 2021 deadline for when the Financial Conduct Authority
will no longer compel banks to contribute to the London Interbank Offered Rate
(LIBOR). There are worries about the possible end of LIBOR, the most notable being
the transition of legacy LIBOR-linked contracts to the new reference rates. Elsewhere
in Europe, methodological changes have been made to the Sterling Overnight Index
Average to strengthen the benchmark, while the method used to calculate the Euro
Interbank Offered Rate will be overhauled by 2020.
Progress has, however, been made in identifying risk-free rates (RFRs) and other
alternative reference rates in currency areas reliant on major IBORs. The focus is now
shifting to efforts to manage what is bound to be a complex transition to these
alternative reference rates. Industry bodies such as the International Swaps and
Derivatives Association have been consulting with stakeholders regarding contract
fallback options, with the aim of agreeing ex ante rather than ex post, on any fallback
arrangements. For cash markets, the Bank for International Settlements suggests that
floating-rate instruments could be converted to fixed-rate contracts or to an adjusted
RFR-based term rate, similar to the option for derivatives contracts. We could also see
some issuers recalling LIBOR-linked debt instruments and replacing them with those
linked to the new benchmarks. Indeed, the Intercontinental Exchange (ICE) has
proposed a US dollar ICE Bank Yield Index. ICE Benchmark Administration anticipates
launching the Bank Yield Index2 in early 2020 should there be a favourable market
response.
Evidently, a blanket solution for benchmark rates does not exist. The ultimate outcome
of transitioning may feature the coexistence of multiple rates and/or benchmarks. It is
important for those of you that have exposures to Libor to not leave it too late in making
appropriate arrangements.
For South Africa, the SARB's publication of a consultation paper3 on selected interest
rate benchmarks last August marked a key step towards the reform of existing interest
rate benchmarks. The consultation paper proposes the adoption of new benchmarks
with the aim of enhancing transparency in the domestic money market while also
enriching the framework for the monitoring and identification of systemic risk.
Extensive research into the robustness and sustainability of the Johannesburg
Interbank Average Rate (Jibar) and the South African Benchmark Overnight Rate
(Sabor) had revealed shortcomings. Specifically for Jibar, the insufficient number of
transactions in negotiable certificates of deposit means that this rate does not meet
the International Organization of Securities Commissions' requirements on data
sufficiency.
The SARB has decided to follow a 'market choice' approach to identifying an
alternative reference rate to replace Jibar. By way of clarification: when we talk about
reference rates in the domestic market, we mean benchmark rates that are used in
the pricing of derivative and other financial contracts, while benchmark rates provide
price indications in the general market. To facilitate market choice, the Market
Practitioners Group4 (MPG) was formed. The MPG is a joint public and private sector
body, which I have the privilege of chairing, with the aim of guiding final decisions on
the choice of alternative reference rates and the operationalisation of proposed
reforms. The MPG has recently established work streams for the purpose of executing
its mandate. These work streams will also advise on transition and other
implementation issues.
Allow me to take this opportunity to thank those of you who have provided comments
on our consultation paper. We plan to publish a report on 24 May 2019 reflecting key
takeaways from the public consultation process, together with our responses and
adopted positions in respect of the reforms. The SARB is as resolute as other
international regulators and policymakers about the need for reform.
All final decisions regarding the reform project will be published in a technical paper
later in 2019, which will detail the benchmark interest rates to be published in the
future. Given the identified shortcomings of Jibar, it is our expectation that the reform
of Jibar will be prioritised by the MPG and its work streams. The interim reform
measure that will ultimately be decided on shall become effective from a future date
that will recognise all data collection and transitioning considerations.
Another collaborative effort - this time between National Treasury (NT), the Financial
Sector Conduct Authority (FSCA) and the SARB - was establishing the Financial
Markets Review Committee (FMRC) to develop recommendations aimed at
reinforcing conduct standards in wholesale financial markets. The earlier review by the
Foreign Exchange Review Committee had recognised room for improvement in
conduct and governance related to the over-the-counter fixed income, currency,
commodities and derivatives markets. In September 2018, the FMRC released a draft
Financial Markets Review5 for public comment. You will be relieved to hear that I do
not intend to discuss all 43 of its recommendations in this speech, but that I would only
like to highlight a few which hold particular relevance for this audience.
The first is the development of a general code of conduct for financial market
participants that would be pre-empted by the formation of a Financial Markets
Standards Group. This group, led by senior market professionals, would provide a
forum to discuss compliance issues and to resolve conflicts in standards of market
practise. Another recommendation is that the necessary data to carry out cross-market
monitoring and surveillance could be collated via trade repositories, aiding both market
discipline and transparency. Regulation covering conflicts of interest and market
abuse will also be considered. And in addition to our review of benchmark interest
rates, regulators may also investigate ways to expand the repurchase market and
encourage technological innovation to aid the competitive landscape.
A final version of the review is being deliberated and will be handed over to the
Financial Markets Implementation Committee comprising representatives from the NT,
FSCA and SARB, to give effect to the recommendations.
Finally, of specific interest to the audience here tonight, may be the progress that the
SARB has made in accommodating collateral substitution in its operations. Changes
to our systems will allow banks to replace or substitute assets used as collateral in the
main repurchase auction, in line with international best practice. In particular, the
SARB will be transitioning the current Master Repurchase Agreements into the Global
Master Repurchase Agreement (GMRA) to allow for this substitution. System changes
are in progress, and full functionality for market participants is anticipated around mid-
May. Once the GMRAs have been signed, our counterparties will be able to substitute
collateral posted at the SARB. Collateral substitution is expected to ease some of the
demand for high-quality liquid assets through a more efficient use of such assets.
More information on these and other initiatives is contained in the FMD newsletter6,
accessible on the SARB website, with some printed copies available here as well.
Concluding remarks
Let me conclude by once again extending, on behalf of FMD and the SARB, our
appreciation to all market participants for your continued support and cooperation,
which has aided the orderly functioning of our markets. A further thank you to those
who participate in our various consultative structures; taking part in these groups is
crucial as we strive to increase the transparency and efficiency of South Africa's
financial markets within an increasingly complex environment.
Last but not least, I would like to thank team FMD for the sterling work they perform
for the SARB and in the interest of our financial system. We also owe thanks to the
SARB protocol and events team, who have temporarily taken over liquidity
management operations from the FMD.
Please enjoy our hospitality, but do save some energy for casting your ballot tomorrow.
Thank you.