Transcript of Question & Answer Session Panel participation at the Australian Securitisation Forum 2019

Thank you, Bianca, for the kind introduction, and thank you for having us here today. I'm excited to have the experts from our regulatory bodies and keen to get their latest views on this critical topic. After we've done some questions, we will be taking questions on the topic, so please work them through the app. So without further ado, Christopher, if I could start with you, is LIBOR really going away? And if so, how does that affect Australian market participants?

Yeah. Well the short answer is yes, LIBOR is going away. The long answer is that whenever I show up at forums, either closed door or open door like this, and there's a public official talking about LIBOR, you're pretty sure to hear about three certainties from them: death, taxes, and the end of LIBOR. So LIBOR just will not be supported beyond the end of 2021. Banks that are making submissions that currently underpin LIBOR have said they won't continue to make those submissions after that date. So in January, 2022, in the immortal words of Mr Praline, who at least had wanted to own a parrot, LIBOR will be passed on, no more, expired and gone to meet its maker.

So how will that affect Australian market participants? Well, LIBOR, as everyone I'm sure knows, is very deeply embedded in financial markets globally. And that's also true of Australian institutions that have quite a bit of exposure to LIBOR products through financial contracts and their business processes. So if they haven't thoroughly prepared, then they risk those contracts being tied up in lengthy disputes, which will be very disruptive to their business and, potentially, for the financial system more broadly.

Yep. Okay, thank you. And Nathan, ASIC sent out a set of Dear CEO letters to Australian financial institutions to get feedback on the progress of their LIBOR transition. What have you learned from those letters?

So I'll go through what we've learnt, but for those that aren't fully aware, we made the call to send letters to the CEOs of about 10 major financial institutions. So that was a mixture of sell side and buy side, so major banks, super funds, couple of fund managers. And really what we were trying to do was gain an understanding of institutions' preparedness for LIBOR transition. There had already been a fair bit of commentary internationally. So we had expected there to be a changes afoot in these organisations and to raise awareness about the issue because we were not sure that the broader industry had really assessed the impact of LIBOR transition on their contracts.

We found it to be a useful exercise, and some of the feedback we received was that, not only did it raise the matter as almost a new matter for a couple of firms, but assisted some institutions in measuring their level of priorities for their projects they were resourcing. So it definitely raised the priority for some of them and highlighted a few risks to them as a result of that. So the information we got back really supported the early views we had, that LIBOR is a substantial part of the Australian market, as well as the international market, and is far reaching. So it affects many core functions from those financial institutions that are surveyed, treasury, technology, operations, business development. It's got tentacles into most areas.

And a couple of little statistics came out of it. Bearing in mind, it's only 10 firms that we went out to, although they are some of the larger firms in the industry, that a significant amount of the contracts have reference rates to LIBOR that expire after 2021. So we were looking at about a 40% of the total volumes seem to be expiring after 2021. So these are contracts at risk that either need to have fallback provisions inserted or new reference rates renegotiated. And about 80% of the national exposure and the information that we received relates to US dollar LIBOR. So that's quite a fundamental part of the LIBOR transition.

There's a mixture of preparedness across the institutions. Those with more global links or intermediary natures of their business were more prepared than, say, others that we reached out to. So they all cited difficulties in the scope of the transition, just trying to manage exactly how far this goes. So they're still in the process when we sent out the letters and received the responses. We have seen a lot of change occurring even over the last few months across the broader industry. The derivatives markets have made better progress than other markets, for example, the debt markets, which are more bespoke in nature and require a bit more work to renegotiate, for example, we might step into that as we go through today.

There's a significant amount of work required in that operational space. Even testing the technology and systems that are capable of dealing with alternative reference rates, managing in arrears, interest calculations and principal changes. So we've been getting a fair bit of information on some of the practical issues that firms are dealing with as part of this.

One area that we noticed only a couple of firms are really focused on, and we have been having more dialogue with the broader industry about is the assessment of conduct risk as part of this process and also litigation risk, which Chris just touched on. So before I go much further on that, they're some of the base level things that we've had coming back. But on the next steps, we're developing our individual feedback for those firms that received those letters. So we are marching towards the end of the calendar year and hoping to get as much of that in place by that time. But we are considering the sorts of messages that we need to deliver to the broader market and, potentially, more of an outreach program to non-financial institutions, i.e. companies that are some of the users of these benchmarks.

Great. Thank you for that. So there's clearly a lot of work to do around LIBOR, but Christopher, maybe I can come back to you. Obviously, as the BBSW benchmark administrator, [I have] slightly a vested interest here, but how is the Australian market different to other markets?

Yeah. So we've talked about LIBOR and its counterparts, which are ending in a number of economies, a number of jurisdictions. And so those economies are being forced to switch across to risk-free benchmarks. We, however, we're not alone in this, but we are having a multi-rate approach. So BBSW has been reformed, so it'll remain robust, and that'll continue to exist alongside the risk-free benchmark, which is AONIA, the Aussie dollar overnight index average … or otherwise known as the cash rate. And that's, of course, what we oversee and publish daily.

So we'll be having both of those, but we're not alone in this sort of approach. Much of Asia is doing something similar. Canada, for example, is also having this multi-rate approach.

To be safe, though, I think it's going to be very important … and Nathan mentioned fallbacks … it's going to be very important for BBSW contracts to have robust fallbacks in place. Indeed, so important that we've said that new securities issued referencing BBSW, they must include the ISDA fallback language, which is going to be provided in detail very soon, in order to be eligible for the RBA's market operations.

Right.

So if issuers want that security to be eligible for our market operations and, therefore, be a bit more liquid, then they've got to adopt those ISDA fallback language. So the details of that are coming out the end of this year.

Right. So that's obviously a really critical factor for everybody here to be aware of, that need for new securities.

Right.

To have the ISDA fallback language in them so they can refer to BBSW, or they need to have the ISDA fallback language in them in order for them to be eligible for RBA operations.

Yeah.

Yeah. Great. So a really important message there. And in terms of timing on that, do you have any guidance on when this applies to new securities?

No. I mean obviously it's going to take a little bit of time. ISDA just recently published a little bit more information about the fallbacks, but the full details of that are due at the end of this year. And it's going to take a little bit of time for this fallback language to reasonably be brought into the contracts for new products.

So the general position is new contracts …

Yes. It'll take some time. So I think that's yet to be determined, but you would imagine people need to be fairly expeditious in doing this.

Yeah.

So over the course of the next year or so, but it hasn't been locked in and determined.

And what about existing securities or anything that's …?

Well, particularly for anything that's going to have a maturity over that end date of end 2021, I think it's still going to be very important for both issuers and investors to come together and adopt these new fallbacks. Now that's a negotiated process of course with contracts. But if you're an issuer, I think, it's good that you can demonstrate that your products are robust. And if you're an investor, you have a fiduciary duty of care to those whose money you're looking after, and you should also be pursuing best practise, which will be to adopt these fallbacks.

Yeah. Thank you for that. So one month, BBSW, and maybe Nathan, I'll direct this to you first. So one month BBSW is used very extensively by this industry, so in the securitisation market. What are your views on the use of one month BBSW as a reference rate for those instruments?

I think I'll start by saying I'm very interested to see what comes out of the Australian securitisation forums server that they did around this from industry. When we look at BBSW as a series of tenors, we are comfortable with that remaining a significant benchmark for the foreseeable future. I'm just going to go through a few things that led us to that, and then touch back on the one month element.

So in your role at ASX that with the ASX Benchmarks Pty Limited, which was licenced as the Australian benchmark administrator in June this year, that enabled us to ensure the reliability marketing to get investor confidence in BBSW, and have a full regulatory framework around the benchmark calculation methodology. So recent work has been conducted to strengthen its robustness and provide fallback provisions to minimise potential future disruptions. And there's ongoing reform work in relation to the calculation methodology. The rate is based on executable transactions and the first level of the waterfall is the NBBO, which is at distinct points in time during the trading window. And then there are further fallback mechanisms, and ultimately it could be a compulsion for submission.

Sitting off the back of that though is the fact that we recognise that the one month tenor is a less liquid part of the curve, primarily because of the regulatory liquidity requirements, and it's more of a buyback market. So there is more volatility in that price point. The administrator keeps an eye on all of the tenors as do the regulators in looking at a whole range of metrics to underpin our understanding of what is occurring in the market. And there's a BBSW oversight committee, and there would be members in this room of that, to look at calculation methodology, but also the metrics that are underpinning this.

So we do look at the IOSCO principles when we're assessing it. We've also got our regulation that underpins how the administrator assesses the benchmark. So the concerns around the one month have been well documented through a variety of speeches, both by ASIC commissioners and RBA and so I think that's well well-documented to date. I think behind all of this in relation to whether the one month BBSW and its use as a reference rate, it's there to be used at the moment. However, we do expect the industry in the context of everything else that is going on, to consider what is the best reference rate for their product suite.

There are a few questions around that, and particularly when you go through things like the international principles on benchmarks. What is the most representative of the underlying product that you're trying to measure? Whether that's a cash AONIA rate, for example, or a term rate. Should there be a credit spread involved in there? These are things that the market needs to consider against each product type that there is.

Yeah, and I think for me, obviously, as the benchmark administrator, we look very closely at all of that data, and in general there's a good amount of liquidity at the one-month point. But I think what it really emphasises for me is that when you're using a rate, it's extremely important to understand what that rate really represents, because the one month BBSW rate, given the bank bill market and as you say, bank's liquidity requirements, banks mostly issue bank bills that are longer dated tenors.

And so the one month point is mostly people buying back securities. So plenty of transactions, but it's primarily a buyback market. And I think when you're thinking about what rate to use for a particular security, it's just really important to understand the nature of the market that you're referencing. And I guess it's the nature of the one month market has really changed, as bank's funding has lengthened out and is generally at longer tenors. So I guess it's that understanding what the content is that you're using, is really important, but Christopher, key messages from the RBA on that topic?

Well, I guess I would echo what Nathan said. And the key message I think is when using a benchmark rate, yes, you have to make sure it's robust, but you also have to make sure it's the right benchmark for the job at hand. So in this case, do you need a benchmark that's based on bank credit risk when you're issuing RMBS? Do you need a term rate? Yeah, maybe. Do you have the right term? But these are the questions that the market has to sort out. I think in that respect, I'd note and welcome the CBA's recent initiative to use AONIA in place of one month BBSW for their new RMBS issuance. So that's something that they're trying out and exploring, and let's see what happens.

Yeah. Absolutely. And then just to follow up from that, so given what we've just heard about one month BBSW, do you see a role for a term risk-free rate in Australia?

Well, we certainly know and hear from a lot of people that there is at least some demand. There's much interest in a term risk-free rate with similar sorts of tenors to BBSW or LIBOR, particularly for cash products because what people want here is some certainty about their cash flows, and term rates provide that certainty.

Now it would be feasible I think … because the cash rate is used extensively in a number of derivative markets already … it'd be feasible to generate a term rate using markets for say OIS futures or repo, or something like that. But I think the most important point is that it's going to take quite a bit of time and a lot of effort to put in the appropriate market infrastructure and to develop the right market practises to establish a new term risk-free rate benchmark that can be considered a robust benchmark. And the end of LIBOR is only 25 months, 12 days away. So we need to encourage market participants ahead of that.

Now of course BBSW doesn't have such a clock ticking on it, and it is a robust benchmark. But I just think that the notion that we can just wait for someone to develop something … well, we're going to be potentially waiting for quite a long time. So again, I'd just welcome the fact that people are out there trying different things and the CBA is one of them in this space.

Great. Thank you. And Nathan, maybe I'll turn to you next, and I'll ask what are you doing at ASIC, to help people with all the work that's involved in this benchmark transition?

I think the first one is the Dear CEO letters, was the first port of call. But really what we have established through that is that there needs to be a broader outreach program to the broader financial community and major companies that are potential users. We are looking to identify better practises and inform the market of those, so they can utilise that experience to be a net information centre.

In relation to those Dear CEO letters, we are working through the information very closely with the RBA and APRA. So we bring all of our different skill sets to that. And obviously we've got different mandates that we bring to it. We have been approached by some of the domestic investment banks that have global programs of work to inform us of what they've been doing, particularly out of Europe. They are quite advanced in Europe, essentially, it started there. We do take those lessons learnt from other parties.

The regulators as a group who are members of and actively participate in international fora. So there are a range of those. There's obviously ISDA work. We do work with the Australian securitisation forum, IOSCO, FSB. There are a whole range of working groups dealing with particular elements of LIBOR transition, and even looking at the context of a European or US model, which is moving all the way to risk-free alternative rates with no alternative, or no IBOR, whereas Australia and other jurisdictions have a multi-rate jurisdiction. And in one of the other conferences, I do remember one of the attendees indicating that at the moment it is about LIBOR transition, at least with BBSW it's not an immediate departure that is going to be assessed on an ongoing basis.

Of course.

And I might park it there. There's a lot of work going on the regulators are doing in this space to try and help the industry, but at the end of the day the industry is going to make the call on which rates they need to move to, depending on what products.

Great. And Christopher, anything to add there in terms of practical help that the RBA is providing over and above what …

We don't have regulatory powers, but we are working very closely, as Nathan said, with APRA and ASIC, that do. I'm also a member of the OSSG, the Official Sector Steering Group, which is tasked by the Financial Stability Board, a group of central bankers, to come together and help efforts to coordinate adjustment to the end of LIBOR. And as I said, we're doing our small bit in providing an incentive by saying for new securities, they have to have the fallback language from ISDA in those securities if they're to be accepted for our market operations.

Yeah. Which is likely to be very helpful in accelerating that, I imagine?

Right.

So just thinking more specifically about the securities industry, I know for derivatives markets, in some ways the problem is potentially a little easier because of the ability to come up with protocols. You know, once the market agrees, we can have protocols to sort of shift terms en masse. But for securities, we have heard feedback already from market users who are really daunted at the scale of work involved in the transition. So what is the scale of work involved, and how are you expecting the market to approach that?

Okay, so I don't have a particular statistic to put back on how big the issue is, particularly for the securities industry, but it has been raised as an issue through our outreach program, and it was very early on. It was recognised that there are different parts of the industry that will need to deal with this transition in different ways. And where it's a one-on-one negotiation with a counterparty, that could be quite an intense negotiation process, particularly in the securities industry. And if those contracts are not renegotiated in a timely manner, there could be a risk of litigation further down the track, and potentially conduct risk type issues as well, or raised as conduct risk issues if there's a winner or a loser at the end of that process.

We would expect that the market would be accelerating at pace, but we do understand that it's got to be a pragmatic view to undertaking this work. So really what we would be looking for at this stage is identification of the magnitude of that for each firm. What are the high risk areas that a firm should focus on in renegotiating those one-on-one contracts? That could be using a whole range of factors to do that. We will be looking to the firms to see if they've got a process around that and make sure that they're managing that risk as best as possible, but we do understand that there are pragmatic issues to deal with a number of potential contracts in the short timeframe.

Now in the interest of time, I'm going to skip to see if we've got any questions, Lawrence.

We do indeed, and I'll try and get through as many of them as I can. First one is, "I understand ASIC has the power to approve new benchmarks. What's the problem with allowing one month AONIA, which is a much better benchmark for investment managers to work with as opposed to just AONIA?

So there is a process where we would approve significant benchmarks. There are five benchmarks on there already, one is the AONIA cash rate. We would assess those as they arise. I think it's different with the RBA as a prescribed entity as part of that process. We'll be looking at a whole range of options. And there is a discussion with industry as to what term rates might be appropriate and who should be the administrator for those.

Okay, thank you. There was a question … I think Chris Kent may already have addressed this, but there was a question specifically about the likelihood of a forward-looking term risk-free rate being developed. Then another related question which is, if term risk-free rates are developed, is there a risk that deals linked to realise AONIA will be orphaned?

Well, I think we're still some way off, as my answer before suggested. We're still quite some way off from having a robust term risk-free rate developed. It's going to take quite a bit of time. It's possible in that time that if people want a term rate based on AONIA and they use a backward looking compounded one, that industry gets used to that. And we've seen industry once they get used to something, can stick with it. So will it be orphaned? I'm not sure. I mean these are all things that the market has to determine, and we can't sort of dictate to the market what should happen.

Okay. Another one. Ultimately most borrowers want to offer the product investors most want to buy. How can we make investors engage more with the issue of transition?

Well I think that's part of the … There is a role for regulators in here as part of our outreach program, but we won't be able to cover everybody in the market. So I think it's almost a joint effort from those parties that fully understand and appreciate the challenges with LIBOR transition and engaging with their client base as early as possible. And that's partly a risk mitigation issue, to make sure that as we've referenced a few times here, potential litigation risks, if they come to pass, could be quite costly for the industry. So it's trying to get ahead of that.

Lawrence, can I just add … I mean I think one thing here to recognise, is that the markets we're talking about, the markets determining what's going to happen, aren't just in Australia. Global market trends, offshore markets moving towards use of say risk-free rates in a lot of products, might convince offshore investors who also come here that that's a product they can be familiar with, that they can trust, they can rely on. So that might force change here as well. That's another thing to think about.

Okay. Just a couple more in the app. This one relates to the fallback language comments that you made earlier, Chris. Is the RBA foreseeing no change in accepting the market operations securities based on one month BBSW in the medium term, provided the use of the fallback language is included?

Yes.

Easy. Okay, so this is the last one. A transition to alternative rates is very resource intensive. How would you suggest smaller treasury teams manage this?

That's a good question.

Well, yeah, I think that's really a question for each firm individually. But what I would say is going back to our Dear CEO letters, that that was found quite useful at the firms who received them in raising the level of priority for this particular work stream. It really helped the firms identify the risks that they have as part of this. But I think that could even go to the internal politics of each firm, so I'll leave my comments there.

I mean maybe I'll just add that I think it's important and appropriate in a forum like this to say those small treasuries need to look to industry associations. I think it can give them some guidance … to follow new protocols and common practices that have been developed by forums like the ASF, by ISDA and the like. Thanks.

And so just to maybe wrap up, to firms who are keen at this stage to wait and see and aren't quite sure of the direction they should take, what would your advice be to them?

Don't wait and see.

Don't wait.

Now. That's a very risky strategy to wait and see.

Absolutely. And any final comments, Nathan?

I would concur with those comments. I have nothing to add from what I've already said.

Great. Thank you very much, I appreciate it.

No, thank you.

Thanks.