Monday 25 July 2016 by FIIG Securities butterfly Education (advanced)

BBSW evolves to suit the times

Rate setting scandals have rocked global financial markets over the last few years. The setting of BBSW, one of the most important benchmark rates for Australian investors and borrowers, has been evolving to suit the times

The bank bill swap rate (BBSW) is one of the most important and widely referenced interest rates in the Australian market. It is the base rate used to calculate payments on hundreds of billions of dollars of securities, and billions more in loans from mortgages to credit cards to corporate loans.

Bank bills are short term debt traded between banks, which buy or sell the notes from each other depending on whether they need money or have excess funds. 

A few years ago, ASIC found evidence that traders had manipulated the BBSW to their benefit and are taking action against three banks – ANZ, NAB and Westpac. The way the benchmark was calculated involved a panel of 14 banks submitting interest rates they were paying and receiving on bank bills. So, bank observed rates were sent to AFMA, which relied on the figures.

To prevent future manipulation of the index, BBSW has been evolving to reflect the traded market and last week, AFMA, released its new and revised standards for calculating BBSW.

The principal feature of the BBSW methodology change is the establishment of a sequentially staged calculation waterfall. The intent being that Stage 1 will be the most frequently used method and Stage 2 and Stage 3 can be employed if trading levels decline.

BBSW Waterfall

Stage 1 Volume Weighted Average Price (VWAP) of primary issuance and secondary trading of Eligible Securities within a trading window defined as 9:00am – 10:10am

Stage 2 National Best Bid and Offer (NBBO) – the current methodology, which uses live executable bids and offers to calculate BBSW, will operate only if Stage 1 fails to form BBSW

Stage 3 Algorithmic calculation – this would draw on relevant market pricing information that is available only in the circumstance where both Stage 1 and Stage 2 fail to form BBSW 

Source: AFMA

According to AFMA, “The waterfall arrangement will support production of the benchmark both under normal market conditions and in a stressed environment. The intention is that BBSW will generally calculate under Stage 1, with occasional use of Stage 2 on lighter trading days. 

Given the level of trading in the market for Eligible Securities and the ongoing operation of the NBBO as the primary fall-back, it is expected that Stage 3 would be rarely used in practice and then would be used for not more than two consecutive days. The introduction of Stage 3 will improve the capacity of the benchmark to withstand short periods of exceptional market stress, irrespective of the source.”

Stage 2 is currently being used while Stage 1 and Stage 3 are under development. AFMA’s market notice also indicated that it was going to hand over responsibility for BBSW benchmark administration to an “appropriately qualified entity” and while they expect to design the new methodology, the new administrator would be responsible for its implementation.

For more information, please refer to AFMA's market notice on the evolution of BBSW methodologyExternal link - opens in a new window and BBSW guide.External link - opens in a new window