Photographer: Carla Gottgens/Bloomberg

First Bank Suit in Aussie Rates Probe Risks Hobbling Benchmark

  • Securities regulator is suing ANZ over alleged manipulation
  • Bank bill swap rate being reformed as trading volumes plunge

Australia’s securities regulator, suing one of the nation’s biggest banks over alleged interest-rate manipulation, risks further deterring the very institutions that are essential to setting the bank bill swap rate, the local equivalent of Libor.

The Australian Securities & Investments Commission said Friday it was taking legal action against Australia & New Zealand Banking Group Ltd. over alleged conduct relating to the rate also known as BBSW that’s used as a benchmark for trillions of dollars in financing. The regulator has been investigating the process for more than three years and in that time participation in the transactions used to determine the rate has dwindled to such a point that Reserve Bank of Australia Assistant Governor Guy Debelle has said reform is needed to maintain its robustness.

Some four years after the scandals surrounding the London interbank offered rate shook confidence in the global banking industry and led to the departures of senior executives, Australian regulators are striving to ensure BBSW is sufficiently strong and transparent, continuing a process that began in 2013. Overseers worldwide are facing difficulties as their efforts to reform financial transactions deter participation and threaten to make markets less efficient.

‘Fallen Away’

“Liquidity has fallen away in large part because the local panel banks are concerned that anything they do might be looked at by the regulators as being an attempt to move the rate or to influence it,” said Sean Keane, an Auckland-based analyst at Triple T Consulting and the former head of Asia-Pacific rates trading at Credit Suisse Group AG. The participation of Australia’s four biggest banks is essential to the rate set and “they obviously need guidance on how exactly to do that, and direction on what records they need to keep as evidence of their fixing submissions,” he said.

BBSW is calculated using live prices from three interbank trading platforms, even though an October report said no activity took place last year during the rate set on about a third of days and overall turnover had slumped. Changes to the Australian system are scheduled to be completed by the end of 2016. Suggestions include expanding the set of transactions on which BBSW is based so that they don’t hinge solely on bank participation.

Bank Probe

The securities regulator plans to probe other big banks for manipulating interest rates, the Australian Financial Review reported on Sunday, citing people it didn’t identify. ASIC is understood to have issued a list of 120 people to Westpac Banking Corp as “people of interest,” the Australian reported this week, without citing sources.

An ASIC spokesman said Tuesday the regulator had no comment to make on questions regarding the impact of the probe on liquidity.

ANZ has said that it will “vigorously defend” itself against ASIC’s action, which Chief Risk Officer Nigel Williams has said is based on a “misunderstanding of how bank bill issuance and interest-rate risk management operates.”

Almost half of Australia’s A$20.7 trillion ($15.4 trillion) in over-the-counter interest-rate derivatives reference BBSW, while A$2.4 trillion of bank loans are linked to the benchmark via wholesale funding costs that reference it, according to an ASIC report published last year.

Unintended Consequences

The Finance and Treasury Association pointed to the unintended consequences of ASIC’s investigation in a December submission to the Council of Financial Regulators during the consultation process on BBSW. The probe may have resulted in “drawing liquidity away from the trading window and so potentially undermined the robustness of the benchmark,” it said.

Average daily turnover of eligible securities during the rate set through 2015 had fallen to around A$225 million from about A$500 million in the year from September 2013, the Council of Financial Regulators said in a paper released in October. The council is a coordinating body whose members include ASIC, the Reserve Bank of Australia, the Australian Prudential Regulation Authority and the federal treasury.

QuickTake Broken Benchmarks

The nation’s big four lenders -- ANZ, Commonwealth Bank of Australia, Westpac and National Australia Bank Ltd. -- are in a difficult position. The so-called Prime Banks must support the approved trading platforms from where pricing is sourced for BBSW, by quoting bids and offers for bank accepted bills and negotiable certificates of deposit, while also holding and trading financial securities priced off the benchmark.

‘Potential Conflict’

“Institutions face a potential conflict of interest when they participate in the market underpinning a benchmark as well as the derivatives market that references the benchmark,” RBA’s Debelle said in a Feb. 22 speech. “Many institutions state they are uncertain about how regulators expect these conflicts to be managed. As a result, they are reluctant to trade during the rate set.”

Debelle said fund managers are also contributing to reduction in turnover as they are reluctant to trade at outright yields, something they would need to do if their transactions were to be included in the process underpinning BBSW. Credit limit restrictions and the impact of regulations on foreign bank demand for paper issued by local lenders was another piece of the puzzle, he said.

Road Map

The Council of Financial Regulators laid out a road map for reform last month after taking on board 15 submissions from market participants. Proposed measures included expanding the band of transactions underlying the fix, widening the window and changing the calculation methodology.

The Australian Financial Markets Association, which administers BBSW, is considering the proposals. The timeline aims for further consultations to be completed by mid-year and changes to the BBSW methodology to be implemented by year-end.

In his February speech, Debelle said challenges remain, including overcoming the reluctance of market participants to trade during the rate-set window and deciding the best method for trade execution, be it through direct negotiation, electronic platform or a tender process.

Liquidity during the rate-set may be further affected in the first few months after changes are implemented as the market gets used to the new regime, said Lee Smales, a senior lecturer at Curtin University’s School of Economics & Finance in Perth.

While the regulatory probe “is having unintended consequences, I do think that it is an issue that needs to be fixed,” said Smales, who spent eight years at Citigroup Inc. trading currencies and rate derivatives. “It’s probably one of those classic cases of maybe short-term pain, in terms of those consequences, for a long-term gain of a fixing that’s going to work better.”

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