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Losing LIBOR: Australia Banks On A Smooth Transition

Australia's banks are on track for a smooth shift away from interbank offered rates (IBOR) to alternative risk-free reference rates by the end of 2021. Like their international counterparts, the move poses challenges for Australia's lenders, but a robust local benchmark tempers the risks, in S&P Global Ratings' view.

Australia Benefits From A Robust Local Benchmark

Unlike in the U.S. and Europe, Australia's regulators are not proposing a wholesale shift to referencing an alternative risk-free rate. This is because the Bank Bill Swap Rate (BBSW)--the Australian IBOR benchmark--remains robust. The key difference between Australia and other IBOR jurisdictions is that Australia's active bank bill market means daily transaction volumes are high enough to calculate a robust interest-rate benchmark. Past concerns over rate manipulation led to the calculation methodology for BBSW being strengthened considerably in recent years. BBSW is now independently calculated by ASX Ltd. based on realized spreads in the Australian interbank market.

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Maintaining BBSW reduces the level of systemic risk posed by the transition in Australia, relative to banking systems in the U.S. or Europe, in our view. BBSW has an existing framework of credit and term spreads and has acted as Australia's primary interest rate benchmark for many years. BBSW also has the advantage of deep liquidity, especially in the three-month and six-month bands. Australia's adoption of alternative risk-free rates supplements the existing BBSW framework, resulting in a multi-rate approach. The alternative risk-free rate in Australia is known as the AUD Overnight Index Average (AONIA).

The BBSW remaining in place, alongside the establishment of an alternative risk-free rate in Australia, provides choices to the market. For example, instruments issued by governments can reference AONIA (a cash rate) whereas floating rate notes (FRNs) issued by banks or corporates may reference the three-month BBSW (a credit-based benchmark). Like alternative risk-free rates in other jurisdictions, AONIA does not yet have an established term market.

A Proactive Approach

In May 2019, the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investment Commission (ASIC), and the Reserve Bank of Australia (RBA) jointly contacted selected major financial institutions seeking information on the readiness of these institutions, and the overall Australian financial system, for a move away from IBOR.

The regulators then followed up with feedback on individual banks' preparations, identifying perceived gaps relative to other respondents. The process also allowed regulators to formulate best practices and share them with industry participants. We believe that this approach will help ensure that all industry participants keep pace with the required changes, putting the ball in motion for banks to start preparing in earnest now that the transition deadline is under a year away.

The RBA has endorsed the Financial Stability Board's roadmap for IBOR transitioning, outlining a timeline banks should aim to meet. If banks follow these steps in a timely manner, we believe they will be ready for IBOR transitioning.

Australian Banks Are On Track

Even under COVID-19, the IBOR transition has remained one of the top priority projects for Australian banks, in our view.

We understand that the Australian major banks have established transition programs, have dedicated teams in place, and are on track to manage the IBOR transition by Dec. 31, 2021. They have identified IBOR exposures, put mitigation strategies in place and set concrete timelines for transition milestones. We believe smaller banks are not as advanced, but they also have significantly smaller IBOR exposure. To complete the transition, banks are shifting new contracts to alternative reference rates, amending legacy contract fallback language, and changing systems and processes to ensure a smooth transition.

In our view, the proposed extension of the five U.S. dollar tenors by the ICE Benchmark Administration to June 30, 2023, will not have a major impact on the Australian banks' LIBOR transitioning plans as the extension is only to be used for legacy contacts and not new transactions after Dec. 31, 2021.

As such, we believe the risk of a disorderly transition is remote and should have no impact on the funding, competitive dynamics, or institutional framework settings of the Australian banking system.

Related Research

This report does not constitute a rating action.

S&P Global Ratings Australia Pty Ltd holds Australian financial services license number 337565 under the Corporations Act 2001. S&P Global Ratings' credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).

Primary Credit Analyst:Nico N DeLange, Sydney + 61 2 9255 9887;
nico.delange@spglobal.com
Secondary Contact:Charlie Cowcher, Melbourne + 61 3 9631 2009;
Charlie.Cowcher@spglobal.com

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