Remarks by Dr Rashad Cassim
Deputy Governor of the South African Reserve Bank,
at the Market Practitioners Group Conference,
The Galleria, Sandton
19 April 2023
1. Introduction
Good morning, all, and welcome to the second Market Practitioners Group (MPG)
conference. I joined this industry body just over a year ago, at a time when the MPG
had already identified a successor rate to the Johannesburg Interbank Average Rate
(Jibar), namely the South African Rand Overnight Index Average (ZARONIA). At the
time, the MPG commenced the foundational work to ensure a smooth and effective
transition away from the use of Jibar.
Various milestones were reached over the past year, including the development of a
mechanism to collect high-quality transaction data to calculate and distribute
ZARONIA rates daily; refinement of the transition plan; publication of a white paper on
market conventions for ZARONIA-based derivatives; and the inclusion of fallback rates
in financial contracts. However, there is a still a great deal of work to do and the eight
MPG workstreams are working full steam to take on board the issues that need to be
resolved.
The objective of this conference is to bring together all the pieces of work into a
coherent strategy, and to give you a clear picture of what the MPG is aiming to achieve
and the direction in which we are moving. We hope that at the end of this conference,
you have a good grasp of what your organisations will require to successfully adopt
ZARONIA and transition away from Jibar.
At the risk of covering ground familiar to many of you today, I will provide some
background and context to our reference rate reform initiative and move on to discuss
transition challenges.
2. Why bother with reference rate reform?
The reform of key reference rates globally began in earnest after the Financial Stability
Board's
(FSB) review of major interest rate benchmarks in 2013-2014, which was a
response to concerns raised by a wide range of stakeholders regarding the reliability
and robustness of certain interbank offered rates (IBORs)1. It had become clear that
IBORs were susceptible to manipulation as their computation relied on indicative rates
supplied by a panel of contributing banks. Furthermore, they had become irrelevant
due to declining volumes of unsecured funding market activity. As many of you know,
the relevant international standard setting bodies require a benchmark to be
representative of the underlying interest rate that it seeks to measure.
To illustrate, some analysts framed the weaknesses in the design of the London
as a case of 'measurement
Interbank Offered Rate (Libor) error'2, pointing out that
Libor tended to be less representative of actual interbank rates during times of stress
as certain contributing banks, being weary of revealing information that might increase
their borrowing costs, would submit biased quotes.
Based on these findings, several jurisdictions convened national working groups to
review their respective IBORs. There was widespread agreement that IBOR rates
should be discontinued and replaced with more robust risk-free or near risk-free rates.
authorities went a step further, such as the United Kingdom's
Some regulatory (UK)
Financial Conduct Authority (FCA), which no longer compelled panel banks to
continue their Libor submissions after December 2021, effectively heralding the end
of Libor3.
3. Is it necessary to do away with Jibar?
Considering the global effort to reform key reference rates, the South African Reserve
Bank (SARB) evaluated the design of Jibar against the recommendations of the
International Organization of Securities Commissions (IOSCO) Principles of Financial
Benchmarks. This was necessary because Jibar, in particular three-month Jibar, is a
widely used reference rate in financial contracts. The latest Jibar-related exposures
survey results estimated that the total value of outstanding contracts that reset against
the three-month Jibar rate exceed R30.6 trillion4. Jibar is also a key input in the
determination of the Short-Term Fixed-Interest (STeFI) Index, which is a non-tradable
index used to benchmark the performance of money market portfolios.
Through this evaluation, the SARB found, like many other countries, Jibar exhibits
some of the weaknesses that were observed in the design of certain IBORs. The
benchmark is based on indicative rates from only five contributing banks, making it
vulnerable to manipulation. However, unlike Libor, the indicative rates are quoted on
active screens, and hence they are tradable for all transactions whose nominal falls
between R20 million and R500 million5. While this feature lends more credibility to
Jibar, on its own it is unlikely to be effective in minimising the risk of manipulation.
Furthermore, the issuance of negotiable certificates of deposits (NCDs), which
underpins the calculation of Jibar, has declined considerably over the years, especially
for the three-month tenor, compromising the representativeness of the benchmark.
Jibar's
Consequently, the SARB determined that design weaknesses will become less
defendable in the long term, and therefore it would be prudent to plan for the
discontinuation of the benchmark and for financial markets to transition away from it.
In the interim, the SARB implemented the MPG's proposed measures to strengthen
Jibar by enhancing the transparency of market activity that underpins the benchmark
and by introducing various provisions in the Jibar Code of Conduct and Operating
Rules (Code). The SARB appointed Strate (Pty) Limited to be the publishing agent for
all Jibar-related post-trade disclosures6. The revisions to the Code have been
completed and adopted and continue to undergo regular reviews.
4. The alternative near risk-free rate, ZARONIA
It may be comforting to know that ZARONIA has been in the making for about five
years. The name of the benchmark was initially coined in the feedback to a 2018
consultation paper in which market participants suggested that the South African
Benchmark Overnight Rate (Sabor) Money Market, a proposed reformed version of
Sabor, be named ZONIA, supposedly given its likeness to the Sterling Overnight Index
the UK's near
Average (SONIA), risk-free rate. Nonetheless, we settled on ZARonia,
where the emphasis was placed on ZAR (i.e. the South African rand)7.
The MPG selected ZARONIA following an in-depth assessment of several
alternatives8, most of which were deemed insufficient against the criteria of reliability,
robustness, frequency, availability and representativeness.9 Prior to making its final
decision, the MPG assessed the suitability of ZARONIA as an alternative near risk-
free rate based on three requirements, which I will now discuss.
The first requirement is rather deceivingly simple. It demands that a selected near risk-
-
free rate should be very close to being risk-free meaning that the transactions
underlying the ZARONIA rates should, to a large extent, not reflect the credit risk of
the counterparties to the transaction. ZARONIA is a near risk-free rate, as it is the
commercial banks' cost of borrowing
overnight, where credit, liquidity and other risks
are minimal.
A more appropriate way to assess whether the risk premium is minimal would require
a comparison of ZARONIA with a secured overnight rate or an extrapolated curve of
risk-free instruments. However, the most available secured overnight rate, the
overnight repurchase (repo) rate, is fraught with difficulties due to thin trading activity
and a high concentration of market players that cause the rate to be wider than
expected. It is also difficult to extrapolate a reliable credit curve from the spread
between Jibar and Treasury bills, as the latter tend to be relatively illiquid due to their
use as high-quality liquid assets (HQLA).
Nonetheless, a crude measure for the risk premium would be to look at the spread
SARB's
between ZARONIA and the policy repo rate. It would be reasonable to expect
that ZARONIA, as an unsecured rate, would be above the repo rate (secured rate) but
remain very close to it. On average, the ZARONIA repo rate spread is about -15.5
basis points10, meaning that not only is ZARONIA close to the policy repo rate, but it
is usually priced below the secured policy rate.
The second requirement relates to the depth of the market underlying ZARONIA. The
IOSCO Principles of Financial Benchmarks recommend that a benchmark rate should
be anchored in actual transactions that reflect the activity of a deep and liquid market,
including in periods of adverse market conditions. This would make the benchmark
more robust to manipulation.11 ZARONIA is supported by a significant amount of
unsecured overnight transactions, which average circa R350.4 billion daily.
The last requirement is whether ZARONIA is 'fit for purpose'. Two distinguished
American academics, Darrell Duffie and Jeremy Stein (2015) highlight that reliable
benchmarks should reduce search costs in over-the-counter markets and ensure that
information asymmetry is largely eliminated.12 Remarkably, this postulation has held
true for ZARONIA. Based on the back-testing exercise results, market participants had
cautioned that ZARONIA may not be suitable for derivatives as the calculated rates
exhibited high volatility, which would limit the predictability of the benchmark and
impede its adoption. The SARB argued that the volatility was largely due to the
opaqueness of the market for deposits. And hence it was expected that the volatility
would decline considerably once the SARB started publishing the rate and market
participants began referring to it in their pricing considerations. Certainly, the volatility
of ZARONIA has been low since the SARB started publishing the rate on
2 November 2022.
5. On the Jibar transition
The transition from Jibar to ZARONIA will require market participants to deal with the
inherent differences in the make-up of each rate explicitly. Naturally, as an unsecured
forward-looking term rate, Jibar contains a premium to compensate lenders for the
risks they assume over an alternative overnight risk-free rate. The risk premium could
characteristics, such
be decomposed into elements pertaining to the borrowing banks'
as credit risk and funding risk, and elements that reflect market-wide conditions,
including the term premium, market liquidity and factors related to the fixing process
and the microstructure of the market.13 Finding the appropriate measure of this risk
premium that could be added to ZARONIA will be important for financial contracts that
will require a Jibar equivalent after it has been discontinued.
Globally, many jurisdictions have adopted the International Swaps and Derivatives
Association's (ISDA) methodology for determining the risk premiums, commonly
referred to as 'adjustment spreads', that should be added to the risk-free replacement
rates for the IBORs. These adjustment spreads are calculated as the median over a
five-year period of the historical differences between the IBOR in the relevant tenor
and the relevant risk-free rate compounded over each corresponding period.14
We have not yet finalised the issue of adjustment spreads in our jurisdiction. The MPG
ISDA's
will examine whether approach is appropriate for the domestic cash and
derivatives markets and consider whether the methodology needs to be adjusted to
change in the SARB's
account for the recent monetary policy implementation
framework (MPIF). This should only matter to the extent that the change in the new
MPIF had a significant effect on the residual risk factors contained in the risk premium.
Nonetheless, the MPG will make a determination on this in due course, as the adjusted
ZARONIA rate will only be used as a replacement or fallback rate after the cessation
of Jibar. Market participants should in the meantime aim to actively transition out of
Jibar referencing contracts to minimise the stock of legacy contracts that will need to
rely on the adjusted ZARONIA as a fallback rate.
Market participants have become accustomed to using forward-looking term rates,
where the interest rate is known in advance.15 While forward-looking term rates are
helpful in ascertaining future cash flows and, in so doing, assist firms and investment
funds to plan better, they also expose the investor to unanticipated changes to the
short-term rates. As such, investors tend to require a term premium to account for this
interest rate risk, which often results in volatility in times of greater uncertainty
regarding the path of monetary policy. An overnight rate is advantageous in this regard
as it should not contain much of this risk. Instead, it should change as the central bank
changes its policy rate. Market participants who still require a term rate should
consider using an average rate based on ZARONIA compounded in arrears. This
requires a shift in the market's convention
from determining interest at the beginning
of the accrual period to determining it at the end of the accrual period.
As many of you know, we have set up various workstreams in gearing up for the
transition. It is not possible here to do justice, to reflect on the rich work of all the
workstreams, but I will give you a flavour of what is being discussed at least in one or
two them.
The Derivatives Workstream has proposed market conventions for interest rate swaps,
whose floating leg will use compounded ZARONIA period average rates that will be
determined in accordance with the ISDA methodology. While the use of compounded
risk-free rates is fairly common in global markets, it does present a significant change
in our market. Firstly, the nature of ZARONIA as an overnight rate will enable the
introduction of Overnight Index Swaps (OIS). In this regard, the Derivatives
Workstream has proposed market conventions that largely align with international best
practice. Secondly, as ZARONIA will track the evolution of actual interest rates, the
need for hedging risk using Forward Rate Agreements (FRAs) will largely diminish.
As a matter of interest, the decline of FRA trading was remarkable in the Libor
transition, where the daily turnover of FRAs decreased from USD1.9 trillion in 2019 to
USD0.5 trillion in 2022, a 19% decline in total over-the-counter (OTC) derivatives
turnover. Much of the residual reflects exposure to USD-denominated turnover and
other currencies that have not fully transitioned to risk-free rates. FRAs that are
denominated in sterling, the Japanese yen and Swiss franc have virtually ceased
trading, with their turnover having declined by more than 90%.16 Therefore, it is likely
that we will see the domestic FRA market decline, and those that wish to speculate on
future short rate movements will likely have to use forward-starting OISs as a
replacement for FRAs.17
Given the progress made by the Derivatives Workstream we expect that the market
should be able to start trading ZARONIA-based derivatives products soon after the
end of the ZARONIA observation period. Nonetheless, we do not discount the amount
of work that needs to finalised between now and then to enable this.
The Cash Market Workstream has begun the work to determine how the loan and
bond markets could adopt ZARONIA. The mandate for the workstream is twofold: (i)
the segments of the market that will 'need' a
determine forward-looking term rate; and
(ii) propose market conventions for the loan and bond markets.
6. Do we really need a forward-looking term rate?
Given the work done for the Libor transition, it was determined that risk-free rates
compounded in arrears were appropriate and operationally achievable for most cash
market segments. In the UK, overnight SONIA compounded in arrears was quickly
adopted in floating rate bonds and securitisations. However, loan markets were slower
to progress and they estimated that about 10% of the sterling Libor loan market by
value would require alternative rates. The 10% largely comprised low-value loans
made to a wide range of smaller borrowers, who could benefit from simplicity and
payment certainty. The policy rate, and in some instances a forward-looking term rate,
would be preferred for them. Otherwise, larger and more sophisticated corporates and
specialist lending sectors tended to use SONIA compounded in arrears.
The Working Group on Sterling Risk-Free Reference Rates identified certain barriers
to the widespread adoption of the overnight SONIA compounded in arrears, which are
instructive for the work programme of the MPG. The barriers included:
•
loan IT and treasury management systems that required reconfiguration to make
them compatible with overnight rates that are compounded in arrears;
•
standardised legal documentation that facilitate syndicated lending and other
loans;
•
the development of market conventions referencing the overnight risk-free rate;
and
• the development of new loan products that reference the policy rate or an
alternative forward-looking term rate.18
It is essential to note that the work on finding a forward-looking term rate, or, in keeping
with the reference rate reform parlance, a ZARONIA term rate, is still at an infant stage.
Previous attempts at constructing a new term rate based on deposit transactions, as
detailed in the SARB's Consultation Paper (2018) and
Technical Specification Paper
(2020), failed due to design flaws and data insufficiency. Developing a ZARONIA term
rate is dependent on the derivatives market building sufficient liquidity to underpin the
term rate. Consequently, we would encourage the market to adopt ZARONIA
compounded in arrears as a primary vehicle for the Jibar transition and not wait for a
ZARONIA term rate, unless necessary.
7. On the next steps
We are almost halfway through the ZARONIA observation period, which will end on
31 October 2023. Market participants should use the remaining time to assess the
implications of using the rate in financial contracts and issues that could potentially
hinder their transition away from Jibar. The MPG structures provide a good platform
for raising such issues, such as the industry task forces that are managed by the
Workstream's
Transition Planning Workstream and the MPG Communications regular
virtual forums, which provide updates on its work programme.19
The SARB would prefer a relatively short Jibar transition period. Therefore, market
participants are encouraged to actively transition as soon as possible to avoid what
was witnessed during the Libor transition. Despite repeated advice from regulators
and national working groups, most market participants did not take any action to
until the 'endgame'
reduce their exposure for Libor was in sight.20 To illustrate, in 2018
the Alternative Reference Rates Committee21 (ARRC) estimated that there were about
USD200 trillion financial contracts that referenced USD Libor outstanding and that
80% of those contracts would mature in the same year. Instead of the value of the
outstanding contracts decreasing over the ensuing years, the contracts increased to
approximately USD223 trillion.22 The stock of legacy Libor contracts would have been
significantly less had market participants taken steps to actively transition from Libor
and not wait for the FCA and Intercontinental Exchange (ICE) Benchmark
Administration to make more definitive statements about the cessation of all Libor
tenors.
The exact date for the discontinuation of Jibar will be determined and communicated
SARB's preference
soon after ZARONIA becomes available for use; however, the is
for the transition period to be less than the five years it took for the Libor transition.
This is premised on progress achieved thus far and our ability to leverage off the work
that has been completed in other jurisdictions. It would be unwise to re-invent the
wheel and develop unique solutions that do not conform to international best practice.
It is essential that each firm plans properly and ensures that sub-business units and
business functions are ready to action the plan accordingly. The checklist for the
implementation of the Jibar transition and ZARONIA adoption23 should include:
•
establishing an enterprise-wide Jibar transition programme across functions and
businesses to manage the transition risks associated with Jibar-related
exposures;
•
quantifying and monitoring Jibar-related exposures throughout the transition;
•
developing a product strategy that includes creating ZARONIA-based products;
•
developing a plan to address the required changes to technological infrastructure,
processes and people skills required for the Jibar transition and the use of
ZARONIA-based products;
•
determining the financial accounting, taxation and regulation considerations;
•
determining the financial, customer and legal implications that will result from the
transition and plan for the inclusion of fallbacks in financial contracts;
•
developing a communications strategy to proactively engage and educate internal
and external stakeholders; and
•
establishing a governance framework with senior executives to oversee an
enterprise-wide Jibar transition programme.
8. Conclusion
The success of this transition is contingent on our attempt to consult as widely as
possible with all market participants and other stakeholders to ensure that all potential
risks are addressed. This conference is a reflection of how serious we are about the
responsibility of ensuring that the process of ultimately moving to ZARONIA is as
seamless as can be. After all, this transition marks a significant turning point in the
Africa's financial markets, given its impact on a broader set of financial
history of South
products in various market segments.
Certainly, the MPG has established various workstreams that will provide industry-
wide guidance and make recommendations on all the essential aspects of the Jibar
and ZARONIA adoption, which will be made available on the MPG's
transition
webpage.
I thank you and wish you a productive conference further.
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