Cash returns no longer set by committee

In the shadow of accusations of rate rigging by several banks the process by which the interbank lending rate is set in Australia is being overhauled. Importantly these changes, while technical in nature, may have material implications for investors seeking to get the optimal outcomes from their cash investments.

What is the state of play now?

Under the existing framework, the Bank Bill Swap interest rate (BBSW) is set by a panel of authorised market participants. Each participant on the panel provides their view on the interest rates at which approved banks are borrowing funds for different maturities from the money market as at 10am AEST. The responses are then averaged to generate a BBSW rate for each 30-day increment out to 6 months. The BBSW rate not only feeds into the calculation of the main money market performance benchmark (Bloomberg Ausbond Bank Bill Index), but are also used to set the interest rates on a range of money market and floating rate securities.

Unfortunately, the main issue with the existing process is a lack of transparency. A lack of transparency brings with it the heightened risk that members of the panel may be tempted to manipulate BBSW to gain more favourable funding outcomes for their respective banks. The potential conflicts came to a head when the Australian Securities and Investment Commission (ASIC) commenced legal proceedings against ANZ, NAB and Westpac over alleged manipulation of the BBSW1. It is for this reason that the regulators, in conjunction with the Australian Stock Exchange, which has now assumed responsibility for maintaining BBSW, have sought to bring greater transparency to the process.

How will the BBSW be calculated in the future?

The key objective of the changes to the rate setting procedures for BBSW is to increase the level of transparency by making the process for the setting of the rate more akin to an exchange traded market, such as interest rate futures. Based on current intentions, and noting that there are still details to be worked through, the general process for setting BBSW will require:

  • Trades between the issuing banks and counterparties to be entered electronically on designated systems.
  • The existence of a trading window each day during which trading between the issuing banks and counterparties can occur.
  • Issuing banks to quote actual bid/offers during the trading window rather than pre-setting issuing rates based on an undetermined BBSW.

With these changes in procedures, BBSW will become the weighted average yield at which approved banks actually issue their money market securities during the trading window.

Greater transparency

The major benefit from the new procedures is that BBSW will be determined by actual trades entered on electronic systems which can be monitored and viewed by counterparties and regulators. Greater transparency will reduce the ability of issuing banks to manipulate the rates earned by cash managers (managers).

Greater uncertainty

The difficulty faced by managers is that under the new system, it cannot be taken for granted that BBSW will be earned. With the existing framework, all issuance by banks is agreed either before or after BBSW is set at 10:00am and simply quoted in terms of BBSW. Accordingly, all managers, irrespective of resources, are guaranteed investing at BBSW i.e. there is a level playing field for all managers with the rate earned set by the “committee”.

Under the new process, the banks will only quote actual bid/offers during the trading window. It is only after the window has closed that managers will be able to see how closely they were able to trade to BBSW; i.e. actual trading will occur within a range around BBSW. As BBSW feeds directly into the performance benchmarks used by most managers, this in turn impacts upon the ability of the manager to perform in line with their benchmark.

Greater resources and skill

With actual bank issuance occurring within a range around BBSW, managers will effectively shift from being price takers to becoming price makers. In such an environment those managers with superior scale and resources have greater potential to trade more closely to the realised BBSW rate. The key issue then becomes how large will the range around BBSW become? Most likely the range will be measured in basis points (100ths of a percentage point in yield) though given the high turnover in cash portfolios, even such small differences can compound over time. A less benign outcome is that the market experiences a much greater level of price differentiation.

Under this scenario, managers lacking in scale and/or resources may face the prospect of investing at rates materially lower than BBSW. Irrespective of which scenario unfolds over time, managers aiming to optimise their return outcomes will need to commit additional resources to management and systems under the new regime.

Make sure your Cash Manager is resourced for the new environment

The changes for setting BBSW are expected to take effect in the first half of 2018. Under the new regime, trading at BBSW is set to become more difficult. Without the ability to lock in BBSW, generating BBSW-like returns will require managers to commit more effort and resources, with a commensurate increase in costs, to facilitate cash management. When hiring managers for cash funds, investors should ensure that managers possess the scale and/or resources to maximise the potential for matching BBSW when investing funds. Failure to do so increases the risk that the returns earned from a cash portfolio may increasingly lag investor expectations.

1 At the time of writing, early October 2017, it appeared that both ANZ and NAB are close to reaching a settlement with ASIC which involves paying a fine but, potentially, not accepting any liability or wrongdoing.


Issued by Russell Investment Management Ltd ABN 53 068 338 974, AFS Licence 247185 (RIM). This document provides general information only and has not been prepared having regard to your objectives, financial situation or needs. Before making an investment decision, you need to consider whether this information is appropriate to your objectives, financial situation or needs. This information has been compiled from sources considered to be reliable, but is not guaranteed. This document is not intended to be a complete statement or summary. Copyright © 2017 Russell Investments. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments.

First used: November 2017; AUST1-2017-10-31-0654