Christopher Kent: Benchmark reforms
Remarks by Mr Christopher Kent, Assistant Governor (Financial Markets) of the Reserve Bank of
Australia, at the Australian Securitisation Forum Virtual Symposium, Sydney, 17 November 2020.
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Introduction
Thank you for the opportunity to speak at the ASF Symposium again this year. Benchmark
reform is a critical issue to all of us since it will help to underpin the healthy functioning of
financial markets.
Much work has already been done in this area, but much remains to be done in the year ahead
as we look to transition away from LIBOR. I'll spend a bit of time reviewing the work ahead of us.
A key aspect of this is the adoption of fallbacks. While these are an important part of the LIBOR
transition, they also should be in place for a much wider range of financial contracts, including
those that reference BBSW.
The end of LIBOR
The end of LIBOR is a certainty. It is critical that Australian institutions - both sell-side and
buyside - are ready for this by no later than the end of 2021.
Institutions need to have done one of two things. They can transition away from LIBOR by using
alternative reference rates. Or, for contracts where that's not possible, they can ensure that
robust fallback provisions are in place. Doing either one will provide certainty about the
replacement rate when LIBOR ends.
Institutions that continue using LIBOR beyond the end of next year face significant legal,
operational and reputational risks. When LIBOR ends, any firms with contracts still referencing
LIBOR - and without fallbacks in place - will face contractual disputes, litigation and frustration.
There is the potential for this to lead to a firm facing financial and operational disruptions. Any
such firms then risk disrupting financial markets more generally. So we all need to get our
respective houses in order.
The state of readiness for the LIBOR transition is something that the RBA, ASIC and APRA are
all watching closely. ASIC and APRA have supervisory responsibilities in this area and
associated powers to pursue if needed.
Our current assessment is that Australian firms have made progress on the LIBOR transition to
date. There is, however, variation across firms and continued focus and effort is needed in the
year and a bit that remains.
The Financial Stability Board (FSB) has recently published a Global Transition Roadmap for
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LIBOR putting a timeline on the steps involved that you should be aiming to meet. In particular:
By now you should have identified and assessed all existing LIBOR exposures and agreed
on a plan to transition before the end of 2021.
By the end of this year, financial institutions should be offering non-LIBOR linked loans to
their customers.
By 25 January 2021, firms should be adhering to the ISDA IBOR fallbacks protocol. (I'll talk
more about that in a moment.)
By mid next year, firms should have established formal plans to amend legacy contracts
where this can be done. They also need to have implemented the necessary changes to
their systems and processes to enable transition to robust alternative rates.
If you follow these steps in a timely manner, your institution will be ready for the end of LIBOR.
ASIC, APRA and the RBA have published a more detailed checklist of the range of things you
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need to make sure you cover in your transition plans.
Fallbacks are important for LIBOR and beyond
Fallbacks will play an important role in the orderly transition away from LIBOR. These will be
necessary in the cases where transition to alternative reference rates for legacy contracts is not
feasible.
This is why ISDA's recent publication of fallback provisions for LIBOR is such welcome news.
These fallbacks will automatically be included in new contracts as part of ISDA definitions from
25 January 2021. And there's an associated ISDA protocol to incorporate the fallbacks in existing
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contracts.
Robust fallbacks will significantly reduce the risks of contractual disputes, litigation and
frustration for firms when LIBOR ends.
Accordingly, ASIC, APRA and the Reserve Bank are strongly encouraging Australian financial
institutions and corporations that use derivatives contracts referencing LIBOR to review and,
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wherever practical, adhere to the ISDA protocol by its effective date. The Reserve Bank has
already adhered to the ISDA protocol, as have some of our major Australian financial institutions.
Again, it is our strong expectation that, wherever practical, Australian institutions will adhere to
the ISDA protocol.
But the need for robust fallbacks goes beyond contracts that reference LIBOR. This includes
contracts that reference other benchmarks, such as BBSW.
Fallbacks provide important insurance. And if there's one thing that LIBOR has shown us, it's that
we shouldn't take existing benchmarks for granted. So the global central banking and financial
supervisory community has been promoting the adoption of robust fallback provisions as part of
the broader program of global benchmark reform.
This is why the Reserve Bank worked with ISDA as fallback provisions for credit benchmark
rates were being developed. We needed to ensure that our local credit-based benchmark,
BBSW, was included in the ISDA fallbacks and protocol.
In time, the Reserve Bank will require securities that reference BBSW to include the relevant
ISDA fallback provisions in order to be eligible as collateral in our market operations. I know that
there is a lot of good work already underway in industry towards developing market conventions
in this area - including by the ASF. In the period ahead, we will be seeking views from market
participants on how and when we are going to implement this new eligibility requirement for our
market operations.
BBSW in the context of global benchmark reform
Australia's local credit-based benchmark BBSW remains robust. A lot of work has gone into
strengthening the methodology underlying its calculation and the supporting infrastructure and
market practices. This has allowed Australia to pursue a multiple-rate approach for our local
reference rates.
This means that, unlike for LIBOR, regulators in Australia aren't advocating a wholesale transition
to referencing the risk-free rate, which in Australia's case is the cash rate, also known as AONIA.
Instead, we expect market participants to choose robust reference rates that best suit each of
their products and situations, taking into account their own and their clients' needs or hedging
strategies:
In some cases, referencing the cash rate will make sense. Floating rate notes issued by
governments, non-financial corporations and securitisation trusts are possible examples.
But in other cases, a credit-based benchmark, like BBSW will continue to make sense.
Floating rate notes and corporate loans issued by banks are examples of this.
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But as I've said before, not all BBSW tenors are as robust as others. In particular, the
1month BBSW is largely a buy-back market. Accordingly, it is less liquid than other tenors. So
users of 1-month BBSW should be considering using alternative benchmarks given the lack
of liquidity in this market.
It's also worth noting that for some products, approaches adopted widely by market participants
offshore will have an important bearing on the reference rates we are likely to end up using here.
So regardless of the robustness of BBSW, we can expect to see a shift towards referencing
risk-free rates in Australia for some products if that is the trend adopted offshore.
The risk-free rate in Australia
Before I conclude, I want to make a few comments on Australia's risk-free rate, which again is
the cash rate.
The RBA is the administrator of the cash rate benchmark. Accordingly, we've made sure that the
procedures underpinning the cash rate are robust. The details of these procedures are available
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on our website. These ensure that the cash rate will continue to be published, even in
circumstances when there are insufficient transactions in the market on a given day to calculate
the cash rate based on those transactions.
These procedures have been put to the test in recent months, as activity in the cash market has
on a number of occasions declined below the relevant thresholds. In most cases, the cash rate
has been determined as the last published rate based on sufficient transaction volumes. But the
procedures also allow for the cash rate to be determined by the RBA in its expert judgement and
based on market conditions. So this has ensured that the cash rate continues to reflect the
interest rate relevant to unsecured overnight funds. In short, the Reserve Bank can assure you of
the robustness of the cash rate as a benchmark.
Thank you for your attention. I look forward to your questions.
1
See FSB (2020), 'Global Transition Roadmap for LIBOR', 16 October. Available at
<www.fsb.org/2020/10/globaltransition-roadmap-for-libor/>.
2
See RBA, APRA and ASIC (2020), 'Regulators Release Feedback on Financial Institutions' Preparation for
LIBOR Transition', Media Release No. 2020-12, 8 April. Available at
<www.rba.gov.au/media-releases/2020/mr20-12.html>.
3
See ISDA (2020), 'SDA Board Statement on the IBOR Fallbacks Supplement and Protocol', Press Release,
9 October.
4
See RBA, APRA and ASIC (2020), 'Regulators urge Australian institutions to adhere to the ISDA IBOR Fallbacks
Protocol and Supplement', Media Release No. 2020-25, 13 October. Available at
<www.rba.gov.au/mediareleases/2020/mr-20-25.html>. The Financial Stability Board also released a statement strongly encouraging
widespread and early adherence to the protocol. See FSB (2020), 'FSB encourages broad and timely adherence
to the ISDA IBOR Fallbacks Protocol', Press Release, 9 October.
5
See Kent (2019), 'Bonds and Benchmarks', Speech at KangaNews DCM Summit, webcast, 19 March.
See RBA (2020), 'Cash Rate Procedures Manual', 17 June, rba.gov.au site. Available at
<www.rba.gov.au/mktoperations/resources/cash-rate-methodology/cash-rate-procedures-manual.html>.