Benchmark rates, including in SA. get reformed & renamed
It all started with Libor, then came Jibar, but don’t count out ZARibor, Zaronia and ZASFR
A couple of years ago, on Creative Concern’s website, Klaus Schwab stated that “the trends that are shaping the 21st century embody both promise and peril”. Today, most focus seems to be on the peril, and daily academic research headlines confirm this.
On the promise side there have been positive strides globally to reform reference interest rates that represent benchmarks.
These benchmarks are broadly defined as “any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined, or an index that is used to measure the performance of an investment fund with the purpose of tracking the return of such index or of defining the asset allocation of a portfolio or of computing the performance fees”.
The reform also commenced with peril when it was disclosed that the London interbank offered rate (Libor) was being manipulated, as explained in David Enrich’s The Spider Network and Liam Vaughan and Gavin Finch’s The Fix. Also, the report by the Fixed Income Clearing Corporation’s markets standards board in 2018, which covered 225 years and identified 25 specific patterns of financial misconduct, of which the manipulation of reference prices (such as benchmarks) is one.
In contrast, some believe the manipulation is what made Libor successful and that manipulation is Libor’s magic!
The reform has been global. The US transitions from US Libor to secured overnight funding rate (SOFR), an overnight rate currently referencing over $1-trillion of US treasury repo transactions. The euro area introduced the European short-term rate (ESTR) in October 2019 to reference and prevent illiquid derivative markets.
An ongoing reform progress is guiding the transition to sterling overnight index average (Sonia) in the UK. Japan follows the multiple rate approach, away from JPY Libor to Tokyo interbank offered rate (Tibor) and its RFR Tokyo overnight average rate (Tona).
In SA, the publication of three consultation papers by the SA Reserve Bank and market practitioner groups form the basis of the reform. The consultation, feedback, and methodology papers in 2018, 2019 and 2020, respectively, have enticed comments. The papers offered 10 key recommendations for public response.
We conducted survey research to ascertain the level of buy-in on the key recommendations published in the consultation and feedback. Generally, respondents believed the reform to be crucial.
Our stance has been that the Reserve Bank should consider replacing the repo mechanism with the placement of negotiable certificates of deposit to support the Iosco standards
However, opinions differ, and the survey was an attempt to lift the veil on views about the local reform as the communication between the Reserve Bank, market participants and the sector associations are not particularly transparent.
Some 73% of respondents agree with the first key recommendation: phasing out the Johannesburg interbank offered rate (Jibar) calculation methodology due to its shortcomings.
As the rate currently does not meet International Organisation of Securities Commissions (Iosco) standards of data sufficiency, a hybrid Jibar is being suggested.
Even this is not fully supported. Our stance has been that the Reserve Bank should consider replacing the repo mechanism with the placement of negotiable certificates of deposit to support the Iosco standards. The multiple rate approach, reflecting risky and risk-free transactions, is supported by 60% of respondents, as per the second key recommendation.
In the methodology paper, the Reserve Bank suggested five secured, unsecured, overnight and term rates, such as the SA rand interbank overnight rate (ZARibor); SA rand overnight index average (Zaronia); SA secured overnight financing rate (ZASFR), the term financial corporate fixed and term non-financial corporate fixed benchmark rates.
Four of these rates are new, and the SA benchmark overnight rate (Sabor) has been renamed Zaronia.
The introduction of ZARibor was suggested in key recommendation five, where 80% of respondents agreed for the rate to be a near risk-free rate, and 90% viewed it as an acceptable overnight interbank deposit benchmark. The feedback and methodology papers share the same sentiment for ZARibor.
Sabor money market, an overnight unsecured funding rate (key recommendation four), is supported by 70% of respondents and by 55% in the FP. The methodology paper has renamed Sabor money market as Zaronia, which excludes foreign exchange swaps and the inclusion of all deposits greater than R20m.
It is generally accepted that the Treasury bill (T-bills) secondary market in SA is underdeveloped. Respondents support liquidity improvements, as suggested in key recommendation six, where 70% agreed with the recommendation. Respondents reckon this should have been implemented a long time ago as there is a massive demand for liquid T-bills.
Whether primary dealers are willing to accept this additional burden is not clear. Respondents view the current repo mechanism as “broken” and weak. Some 90% of them support key recommendation 10, the development of a broader general collateral repo market with a more extensive pool of collateral.
Key recommendation seven suggested the introduction of SASFR based on supplementary repos. About 70% of respondents disagree with this. However, in the methodology paper SASFR has been named ZASFR and will be a risk-free rate, excluding supplementary repos. It will be used for derivatives and secured items and as a reference rate for the overnight index swap markets.
A small-term deposit market, limited data, illiquidity and lack of transparency are reasons 60% of the respondents disagreed with having term deposits as an alternative benchmark. The methodology paper introduces two-term rates to address these concerns, but the market’s response on this is unclear.
So, while Libor is entering the endgame, benchmark rate reform in SA seems to face a few remaining hurdles.
• Dr Lamont is senior lecturer in investments, and Kapenda a post-graduate student in economics, at Stellenbosch University.
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