Principles underpinning Australias benchmark interest
rate could be extended to the London Interbank Offered Rate
(Libor) to improve its transparency, integrity and avoid scope
The benefits of a prime-bank system based on actual trades
in homogenous paper, as is used to calculate Australias
bank bill swap reference rate (
BBSW), have become apparent in the wake of the rate-fixing
scandal. Libor could be improved by looking at the
The BBSW process of itself isnt easily
transferable but some key principles could apply, David
Lynch, executive director of the Australian Financial Markets
Association (Afma), which publishes BBSW, told
The accuracy of a prime-bank actual trade system makes it
unlikely that the BBSW will ever face the allegations
surrounding Libors interbank system. There are a
number of factors that militate against that, said
The primary factor is that BBSW is calculated based on 14
panel banks observed rates in an actively traded market
for paper of the countrys four biggest, or prime, banks.
Prime paper, as it is known, trades on a homogenous basis,
rather than individually, which helps promote liquidity.
The fact that prime paper is traded in a broker-based market
adds to the rates credibility.
The trades are being conducted by brokers in the
market, which means its pretty transparent. There is a
great degree of price discovery in terms of the trades that are
taking place, said Bryan Paisley, a partner with Baker
& McKenzie based in Sydney.
In contrast to the bilateral
nature of Libor calculation, the BBSW measures the rate at
which the market is willing to lend to the prime banks (ANZ,
Commonwealth Bank, Westpac and National Australian Bank).
In contrast to the interbank nature of Libor, entities other
than banks hold prime paper. So those giving oversight of
the market, in that sense, extend beyond banks to investor
managers, for example, Lynch said.
Transferability to Libor
Since June 28 when
Barclays was fined by US and UK regulators for falsifying
Libor rates, market commentators have debated
how Libor must change.
As indicated in
IFLRs poll earlier this month, a new version
of Libor based on actual trades has some support.
According to Lynch, this is one of the BBSW principles that
could be applied to Libor. The extent to which you have a
foundation in actual transactions, the more likely you will
have an accurate rate. It also creates an audit trail for an
interbank system like Libor, he said.
This audit-trail, along with the fact reported rates are
observable in the market leading up to the 10am reporting
deadline, would help avoid criticisms over lack of regulation
or supervision as has been directed at Libor.
The accuracy of the actual-rates system is reflected in the
small number of outliers in rates reported by the panel.
For Libor, in the normal course youll find that
you get a natural spectrum of contributions by panellists,
whereas for BBSW the panellists should all be reporting
essentially the same rate, Lynch added.
The website of the British Bankers Association, which
publishes Libor, states that Libor
was calculated on a prime-bank basis prior to 1998, but not
For a system based on actual trades, liquidity is the key.
The question appears to be how to make the interbank
market more active, so it produces more transactions and
therefore rates that are observable, said Lynch.
An obvious difficulty extending the actual trade model to
Libor is the sheer number of indices it encompasses. Every day
Libor generates 150 rates based on 15 maturities and 10
currencies. BBSW, on the other hand, produces 6 rates.
This begs the question whether the full range of indices is
needed, or if Libor could be scaled back to focus on areas
where there is sufficient liquidity to accurately price
Rate of choice
Libors Australian dollar rates could be a prime
candidate, in this regard.
For syndicated loans denominated in Australian
dollars, it [BBSW] is basically ubiquitous in the local
market, Paisley said. Its dominance means the
countrys bank Australian dollar sector could operate
Its a testament to the markets faith in the BBSW
The robustness of Australias financial system
and broker regulation means people are positive about the
regulatory set up, and pretty positive about BBSW being an
accurate benchmark, Paisley said.
New Zealands reference rates, as published
by the New Zealand Financial Markets Association, are also
based on actual trades.