Financial markets around the world are in varying stages of transition to new interest rate benchmarks. Existing reference rates – with LIBOR (London Inter-bank offered rate) the most well-known internationally – are losing liquidity and regulators around the world have indicated that alternatives must be found. Australia is no exception.
The Reserve Bank of Australia (RBA) has commented on the lack of liquidity in the one-month bank bill swap rate (BBSW), saying that “users of 1-month BBSW should be preparing to use alternative benchmarks. This is particularly relevant to the securitisation and derivatives markets, which frequently reference the 1-month rate.”1
From Inter-Bank Rates to Risk-Free Rates
To replace it, the Australian Securities and Investments Commission (ASIC) has declared the Australian Overnight Index Average (AONIA) as a significant financial benchmark in Australia. AONIA is the daily RBA Interbank Overnight Cash Rate (currently 0.75% as of 22 November 2019). It is the unsecured overnight rate based on the weighted average of the interest rate at which overnight unsecured funds are transacted in the domestic interbank market. Over the last year there were an average A$4 billion transactions daily.
As Australia’s largest home lender, we felt it was important to lead the development of a new and more appropriate benchmark for residential mortgage-backed securities (RMBS) issuance. We believe AONIA is a robust reference rate for use as a risk-free rate and an appropriate benchmark for RMBS. In November, we arranged and led a A$1.5 billion Prime RMBS under our Medallion programme, Medallion Trust Series 2019-1. It is Australia’s first AONIA-linked securitisation and in line with developments in offshore markets. UK RMBS issuance references the Sterling Overnight Index Average (SONIA), also a risk-free rate.
Broad stakeholder engagement
Being the first AONIA-linked RMBS required engagement with both industry and our own stakeholders over the course of a year to ensure investors, systems and capabilities were ready for a new benchmark. Parties engaged included the RBA, trustees, rating agencies, Intex and SF Portal, Austraclear, lawyers, custodians and, of course, investors.
Unlike BBSW and Libor, where the reference interest rate is known on the day of pricing and coupon resets, with AONIA the rate is only known retrospectively. So, to be more technically accurate, the Medallion Trust Series 2019-1 is the first RMBS to use the Compounded AONIA rate.
We therefore engaged early with the Australian Financial Markets Association (AFMA) to initiate development of market-accepted pricing formula for AONIA-linked securities. We worked with the Australian Securities Exchange (ASX) to determine the comparability of Compounded AONIA and ASX-Realised AONIA formula for market consistency and we also liaised with calculation agents to decide if an external calculation agent is needed. It was also essential to work with Bloomberg to ensure it developed the capability to calculate Compounded AONIA and accrued interest. Its <BXT> function enables users to see the AONIA values used to calculate the Compounded AONIA benchmark rate.
Investors welcome capital-relief RMBS
Early engagement with wall-crossed investors gave us an understanding of investor appetite, views and constraints. An iterative process of updating the deal’s structure and characteristics based on investor feedback followed. After the deal’s launch, there were further discussions with the investment community, this time with a focus on why AONIA is a robust and appropriate benchmark for RMBS and explaining technicalities around the methodology of Compounded AONIA.
The deal was initially launched as a A$1 billion transaction but was upsized to A$1.5 billion based on strong investor demand for all seven classes of notes, including the unrated Class F securities. The notes priced in line with price guidance, with the total order book exceeding A$2.3 billion.
The notes were placed with 24 investors, with balanced interest from real money accounts and balance sheet investors, both domestic and offshore. Medallion Trust Series 2019-1 achieved both of our objectives – capital relief and broad distribution to investors.
The benefits applicable to Medallion Trust Series 2019-1 apply across a range of Debt Markets and Securitisation clients. Our deal team is actively working to leverage all learnings from the deal for the benefit of our client base and the Australian securitisation market as together we move to a new and more appropriate reference rate.