- Like their international counterparts, Australian banks face risks in shifting away from interbank offered rates.
- The local interbank swap rate remains a robust benchmark in Australia, which reduces these risks.
- Banks and regulators, in line with other developed countries, have taken a proactive approach to managing the 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.
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' Exposure To LIBOR Is Significant
The notional value of contracts that reference the London interbank offer rate (LIBOR) or other benchmark rates in Australia is significant at about US$7 trillion , according to a joint feedback report from APRA, ASIC, and the RBA in April 2020. Of this amount, 40% will still be in place as of Dec. 31, 2021, the official end of IBOR. This represents about 2% of the global total of about US$370 trillion. We note that a portion of this exposure is based off U.S. dollar LIBOR, which is currently scheduled to be published for an additional one-and-a-half years (June 30, 2023), before also coming to an end.
The Australian major banks' corporate and investment banking arms have the lion's share of exposure to IBOR transitioning risks. These exposures primarily encompass loans, derivatives, and FRN products that still reference LIBOR or other IBOR rates. For smaller banking institutions such as the regional banks and mutual banking institutions, exposure to IBOR transitioning is far less. Unlike some of their U.S. and European counterparts, Australian banks do not generally rely on IBOR rates for retail loan pricing.
Derivatives represent the bulk of Australian banks' LIBOR exposure. This reduces the risk posed to Australian banks, in our view, as many derivatives are contracted under the International Swap and Derivatives Association's (ISDA) master agreements. ISDA's updated fallback provisions, which take the end of IBOR benchmarks into account, came into effect on Jan. 25, 2021, and now apply to both new and existing derivatives contracted under ISDA's master agreements.
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.
- Losing LIBOR: Most European Banks Are Unlikely To Face A Cliff Edge, Sept. 30, 2020
- Credit FAQ: How To Say Goodbye To LIBOR Without Creating Market Chaos, Sept. 23, 2019
- Credit FAQ: SONIA As An Alternative To LIBOR In U.K. Structured Finance Transactions, Feb. 6, 2019
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;|
|Secondary Contact:||Charlie Cowcher, Melbourne + 61 3 9631 2009;|
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