Transcript of Question & Answer Session Panel participation at the International Swaps and Derivatives Association

Now I'd like to … I'm going to have a fireside chat with Assistant Governor, Chris Kent from the RBA. Can I have Chris? There he is. Come on up. Chris, thank you very much for joining us here today. As Drew just laid out, we have an aggressive LIBOR schedule to go. There's many moving pieces everywhere. As the team goes, we have conversations with the official sector regulators in more than the major jurisdictions, a lot of other jurisdictions that are affected by this as well and this is an important deal. So I'm going to stick to the LIBOR questions here and we're going to kind of help the market, and our audience here, kind of work through some of these technical details.

So let's start off with … I thought Drew did a fantastic job to kind of give us that urgency. But, in your words, and as a representative of the RBA, kind of give a perspective, what the audience needs to be thinking about, in terms of transition off of IBORs?

Yeah, thanks Scott. I'll try to … I think I'm going to echo a lot of what Drew said. But thanks also … Let me thank also ISDA, for the invitation to be here today.

So what does cessation mean? Well, as everyone here knows, and Drew emphasised, LIBOR is deeply embedded in global financial markets. It's used extensively here. Drew quoted a number which suggested Australian financial institutions exposures are very substantial to contracts that reference LIBOR. I think I would echo what Drew was saying, the end of LIBOR is not a risk. It's a certainty. That's how I think of it and the risk really is that people are not ready for LIBOR, when it's not going to be supported after the end of 2021. So the finance industry needs to be ready for that and the risk is that they're not ready. If they haven't shifted new contracts to other reference rates, or inserted robust fallback provisions into existing contracts, into existing arrangements, then those contracts will be tied up in very lengthy disputes.

Now that's going to be very harmful for the institution in question, but it's also potentially very harmful for the financial system more broadly. So how should people be preparing for this? Fairly obvious, but the most senior staff in institutions really need to understand their exposures. There's the obvious, understanding the size and the nature of their on and off balance sheet exposures. There's maybe the less obvious, which is sort of their exposures through their use of LIBOR pricing, how it's used in models, how it's used in risk management strategies.

So they need to understand those things, and they need to start making a plan as to how to address them, and then they need to act on that plan, if they're not already doing so. So they need to transition to new alternative rates, such as transactions based on new risk-free rates for new products, for example. They need to adopt robust fallback provisions for existing contracts, referencing LIBORs. And perhaps, maybe slightly less appreciated, they need to be thinking about operational processes, changing those, changing their IT infrastructures. There's a lot of work that needs to be done. And a very critical way of doing that is to engage with industry, like ISDA. But there are other forums, like the Australian Securitisation Forum, there are loan market associations around the world.

So those are some of the things I think they should be doing and thinking about.

I think that's great, what should everybody be doing? But as you can appreciate, not everybody is doing the same thing and I think we have banks that are probably more advanced in the preparation, and clients, as Drew noted, that are not as prepared. Are you satisfied with the progress with the Australian markets to date, kind of those participants, and more specifically, are you satisfied with the progress of the corporate level?

Right. Well, I think it's worth just stepping back for a minute, and remembering that in Australia's case, as is true of a number of other economies, we're in a place where we have a multi reference rate approach. So we have different sustainable benchmarks that can exist side by side. So the obvious ones are AONIA, or more informally known as the cash rate. So that's something that the Reserve Bank oversees. We manage that benchmark. We publish it daily.

Then there's BBSW. That's an important, longstanding term, credit based benchmark in Australia. A lot of work's already been done to make sure that those are robust benchmarks, so it's operating on a sustainable basis unlike LIBOR. More work needs to be done here though. Notably adopting those robust fallback arrangements when they become available. So I think in Australia we've got a few signs of people making some progress in the markets, but they're very tentative so far. The one everyone points to is the South Australian Financing Authority. They issued a floating rate reference note referencing AONIA. Australian major banks are stepping up here, at least offshore. They're issuing floating rate notes, floating rate bonds referencing SONIA, which is the UK reference rate.

But more generally across the industry, one of the things that's happened is ASIC, with the support of APRA and the Reserve Bank, have written to CEOs of quite a wide range of Australian financial institutions, just asking them about their preparations. So that's going to provide us some helpful information to answer quite specifically your question. So the details of that are coming out later this year. The preliminary sort of analysis suggests that there's quite a bit of difference in terms of state of readiness. Not surprisingly, larger internationally exposed institutions, the major banks for example, they're a bit further along the path, in terms of their progress, but they still have a lot of work to be done.

I think of a bit more concern, perhaps, is some of the smaller institutions, and those on the buy side of things. They're a bit less well prepared. They are more resource constrained, they're smaller, they need a lot more external expertise to draw upon. So ISDA, the work it's doing with others on a number of initiatives, we encourage all of these firms to engage with those, and act in a timely way, and be ready to adopt this fallback provision.

So there's quite a bit of difference across industry. A lot of work for everyone to do, but most particularly amongst the buy side institutions, and among nonfinancial firms. Quite a lot of them have exposures.

We've found, and I think you articulated quite well, they're the operational things. Developing the systems, having your documentation in place, thinking about all the transitional items that you need to do, developing curves, et cetera. Getting your new information, getting your new trading strategies.

And therefore, the next step in this process, and this is something that ISDA's going to be very focused on over the next year, is the market, the trading itself, and the liquidity. What are the products you can use to trade these things, these new products? Is there enough liquidity to trade these things? And how do you think about some of the basis risk? Because whether we have a pre-cessation trigger event, where you could have LIBOR matched up against some of these new risk-free rates, and in a multi rate approach, you want to think about your various trading strategies.

Now, there's two parts to this, I think. And there's obviously the buy side/sell side readiness question, in terms of market trading. But there's also the key infrastructures, entities like ASX, that can play a role in this. Other trading platforms across the globe, there's a lot of trading cross currency in this part of the world.

So what is your opinion – two part question. What is your opinion of the readiness in market, in trading and liquidity, in developing that market for the market sector, and particularly the infrastructures? And then what do you think the readiness of, kind of the official sector is, in terms of in helping that along, and building that liquidity and getting people to move to trade these new products? It's always this chicken or the egg question. Is it the issuance that drives it, or is it market liquidity that'll pull people to trading? So for SONIA, AONIA?

That's a good question. I might just sort of step back and emphasise, where we're at with BBSW, because I think that's important first to acknowledge. So the new arrangements, they took quite a lot of time to put in place, but they're there. There's an updated methodology for calculating them. It's based on transactions in the bank bill market during the rate set window and that's been in place for about a year or so. My sense is, liquidity in that market is quite good, particularly for three and six month BBSW, maybe less so for one month. So that's a question mark there, which I have raised in the past.

Getting there has very much been a joint achievement. The ASX that administer the benchmark, the market participants, the regulators, working together. It was a lot of work to develop the new infrastructure in those market practises. We've made some small tweaks to our own operations. So we've brought forward the timing of our open market operations, just to assist with the provision of liquidity during the period of the rate set window. So I think again, they're working well, particularly for three and six month BBSW. I think in terms of where the market goes, in terms of the possibility of other reference rates being developed and liquidity, largely a lot of that work is happening sort of offshore and so we don't have a strong role for that.

But domestically I think people do need to think very carefully about, are they using the right benchmark for the right purpose for the products that they have? So as I said, SAFA decided it wasn't appropriate to use something like BBSW for a state government institute, issuing their bonds, their floating rate bonds, their notes. So they shifted to AONIA, which is much more appropriate, in their minds. So I think that sets a very useful precedent for other. But those sort of moves and changes in Australia are very tentative, in their early stages, and a lot more work needs to be done.

So I think on the buy side, what I'd urge people to think about, is that because buy side firms have a duty of care for those whose money they look after, I think they need to think very carefully and favour products that are set up with the appropriate reference rate. Because they themselves want to be thinking about, are they doing the right thing in investing their client's money in a product that maybe is referencing the wrong rate?

Let's take it even deeper now in this market liquidity question. Australia's cross currency swap is the biggest trade. 70% of Aussie dollar trades are done outside the country, in the major money centres. And whether it's dollar or GBP, this could obviously have a huge impact in terms of that relationship to the risk-free rates. When market participants are thinking about the switch, they have two options. There can be some kind of a SOFR to BBSW trade cross currency swap, or the market could develop a preference for kind of a risk-free rate to risk-free rate. What is your opinion on that? And how do you see that playing out? And maybe, how do you advise market participants around that?

We don't have a very strong perspective on this. I'd mention that the alternative reference rate committee, which is a group of private sector participants convened by the New York Fed, is thinking very carefully about exactly this issue. Within these cross currency swaps, how do you marry up the different reference rates? So they're trying to develop some new conventions that are going to facilitate this sort of decision. Whether you have, for example, risk-free rates on both sides, or maybe a mix, risk-free rates on one side, and IBOR, like a BBSW, on the other. It's not really clear. I think what they are saying, and makes a lot of sense, is you want consistency across, within a given currency pair.

I think the one thing that we should acknowledge though, that there are lots of currencies that are maintaining these interbank overnight rates, so we're not alone with BBSW. The same is true of Japan, the Euro area and Canada. I think if the swap markets shifted largely to a risk-free to risk-free offshore, in that world, I think it would be making sense for Australia to move towards AONIA, the cash rate being on one side of that. But that's a decision for players in the market. That's not a decision for the regulators. And I imagine very much, that in Australia we'll just be driven by trends offshore.

Drew mentioned that the term rate, which was pretty important to his clients, and a forward-looking term risk-free rate, there's various stages. The US are looking at it, England's looking at it. Would an IOSCO compliant forward-looking term, IONIA, assist with some cash market, making the transition, do you think that would be helpful? And do you see that as a possibility?

Well look, we certainly know, and well aware, that there's quite a lot of Australian investors who have expressed an interest in term risk-free rates. With similar tenors to sort of what are there for LIBOR and BBSW. That's especially true for cash products.

So some benchmark users value the certainty that comes with having an ‘ex-ante’ term rate to hand, in order to calculate all of the cash flows that they need to process, rather than to have to compound sort of an overnight risk-free rate, after the fact, for example. Now the cash rate's already used pretty extensively in quite a few derivative markets. It's possible therefore, one can imagine generating a term rate using markets, for say, OIS futures, repo, something like that. But I think the experience of upgrading BBSW suggests this is a long, careful process. You need considerable effort to put in place the infrastructure and the practises, before it could be considered a robust benchmark.

And I think given the time pressures that you emphasise with your clock, that Drew sort of highlighted again, given that, we're so close to the end of LIBOR, I don't think there's time to really develop those carefully.

I think people should give consideration to using the cash rate, rather than waiting for a term rate to be developed. Of course, if term's really important to them, at least in Australia, they can continue to use BBSW. But it's not an option, again, to wait.

We're at the end of our time. Any final words in terms of …

Oh, well, I'll emphasise that, look, LIBOR's fast approaching. We're already working hard, including with financial market participants here in Australia, to get ready for that, but there's a lot of more work to be done. And a key challenge, I think here, is to get the attention and the buy side firms. We've taken a lot of good steps to make sure BBSW is robust, and I just think the LIBOR lesson says, "Don't take that for granted." So definitely people need to be thinking about putting robust contractual fall-back arrangements in place. And users of BBSW may want to consider whether that's the best reference rate for their product, at least for some contracts.

And there's a lot of work that needs to be done, and maybe you'll be talking about it later today, we didn't talk about it now, but cash products, loans for example, I know it's got a mention this morning, but they're very bespoke. They have to each be negotiated individually. There's a lot of work that needs to be done there.

We're very mindful of, it's not only a derivative play, and we want to coordinate with our colleagues and other trade associations in other spaces, to make sure that that alignment and the transition works for everyone.

Ladies and gentlemen, please join me in thanking Assistant Governor Chris Kent.

Thanks very much Scott. Cheers. Appreciate that.