Key Takeaways
- 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.
Related Research
- 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; nico.delange@spglobal.com |
| Secondary Contact: | Charlie Cowcher, Melbourne + 61 3 9631 2009; Charlie.Cowcher@spglobal.com |
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: research_request@spglobal.com.