Editor’s note: This is general educational information about the Australian dollar bank bill swap rate and the regime that governs it. It is not investment advice and does not describe any current market event or recommend any security. It draws on the ASIC media releases, regulatory guide and BIS publication listed at the end.

Analysis: what a transaction-anchored benchmark can and cannot fix

The reform substituted one dependency for another. A quote-based rate depends on what a small panel says it would trade at, which is what the litigation was about. A transaction-based rate depends on there being enough transactions, which is why the regulators paired the method change with an explicit request that participants concentrate their trading in the window. A rate anchored to real trades in a market nobody trades in would be no more robust than the old one, and the requirement for a final stage method built on expert judgement is an acknowledgement in the rules themselves that the transaction supply can fail.

Australia’s choice also runs against the direction taken with some other benchmarks. The BIS notes that Sydney’s BBSW sat among at least 13 similar poll-based or quote-based benchmarks worldwide, and that several jurisdictions with their own such rates opted to reform and retain them where reform was feasible, so that a credit-sensitive term benchmark coexists with a local risk-free rate. It records that the reformed BBSW is based primarily on transactions, supplemented with executable quotes when necessary, alongside an overnight benchmark based on the RBA’s cash rate. Keeping a credit-sensitive term rate is a deliberate decision, not an absence of one.

The penalty reasoning is the part worth remembering when reading about benchmark conduct. The court set the maximum available and said it would have gone considerably higher, which means the deterrent in this area has come less from the size of any single order than from the structural changes that followed: a specific manipulation offence, a licensing regime, and a calculation method that is harder to move with a handful of trades.

What the documents say

BBSW is a number produced in a short daily period called the rate-set window, and for years the problem with it was not the arithmetic. It was the thinness of the market underneath. ASIC has described the difficulty in plain terms: BBSW was previously calculated from the best executable bids and offers for Prime Bank securities, and a major concern over recent years was the low trading volumes during the rate-set window, the period over which BBSW is measured. A benchmark measured over a window in which very little trades is a benchmark exposed to whoever chooses to trade in it.

What changed in the calculation

The fix was announced by ASIC and the Reserve Bank of Australia when the new method commenced. The new methodology calculates the benchmark directly from market transactions during a longer rate-set window and involves a larger number of participants, which means the benchmark is anchored to real transactions at traded prices. ASX, the administrator of BBSW, consulted market participants on the method and ran it in parallel against the existing one before the switch.

The regulators also told the market what behaviour they expected alongside the new arithmetic. ASIC and the RBA said they expected all bank bill market participants, including the banks that issue the bills and the participants who buy them, to adhere to the ASX BBSW Guidelines and support the new methodology, adding that the rate-set window is the most liquid period in the bank bills market and that participants are therefore likely to get the best outcomes for their institutions and clients by trading during it. The stated expectation was that participants would put procedures in place so that as much trading as possible happens inside the window.

The RBA’s then Deputy Governor Guy Debelle described the effect as strengthening BBSW by anchoring the benchmark to a greater number of transactions, and ASIC’s Commissioner Cathie Armour said a transaction-based BBSW supports the market’s trust in its robustness and reliability.

The enforcement history that sits behind the redesign

The methodology change did not arrive in isolation. The Federal Court ordered Westpac Banking Corporation to pay a pecuniary penalty of $3.3 million for contravening section 12CC of the ASIC Act through its involvement in setting BBSW in 2010. The judgment delivered on 24 May 2018 found that on 4 dates in 2010 the bank traded with a dominant purpose of influencing yields of traded Prime Bank Bills where BBSW set in a way favourable to its rate set exposure, and that this was unconscionable conduct. The court also found inadequate procedures and training and contraventions of its financial services licensee obligations under the Corporations Act.

Justice Beach was explicit about the ceiling he was working under, saying that if permitted he would have imposed a penalty of at least one order of magnitude above $3.3 million to achieve deterrence, and that the message to send is that manipulating or attempting to manipulate key benchmark rates is likely to draw the maximum penalty available at the time. The court also ordered an independent expert, agreed between ASIC and Westpac, to review the bank’s systems, policies and procedures and report back within 9 months.

That case was one of four. ASIC commenced proceedings against Westpac on 5 April 2016 over trading between 6 April 2010 and 6 June 2012, mirroring proceedings against ANZ, National Australia Bank and Commonwealth Bank of Australia.

The licensing regime that now sits on top

Part 7.5B of the Corporations Act, inserted by amending legislation, provides the regulatory framework for financial benchmarks, including a licensing regime and rule-making powers for ASIC. Section 908AB defines a financial benchmark. Under section 908AC, ASIC may declare a benchmark to be a significant benchmark by legislative instrument where it is satisfied that the benchmark is systemically important to the Australian financial system, or that there is a material risk of financial contagion or systemic instability if its availability or integrity were disrupted, or that there would be a material impact on retail or wholesale investors in that event. Administering a significant benchmark without a licence is an offence.

ASIC used those powers to declare certain benchmarks significant, to write rules supporting the licensing regime, and to give itself the ability to require by written notice that a significant benchmark continue to be administered or that submissions be compelled. The same legislation made manipulation of any financial benchmark, or of products used to determine one, a specific offence subject to civil and criminal penalties.

BBSW carries an extra obligation that most benchmarks do not. Rule 2.2.5 of the administration rules requires a licensee whose licence specifies the BBSW to maintain a final stage method for generating the rate when normal methods have failed or are likely to fail, and that method must require contributors to provide data based on the exercise of expert judgement. ASIC’s guidance sets out when it might compel submissions using that method: where ASIC and the RBA consider it likely BBSW cannot be determined by the ordinary calculation mechanisms, or where the administrator tells them it is likely unable to continue administering the rate, including where it is using a calculation method that can only be used for two days. ASIC says it would impose that requirement on contributors appointed or eligible to be appointed as prime banks.