Libor scandal reaches NZ as OCR becomes the fall-back benchmark

RBNZ assistant governor Christian Hawkesby. Photo / Supplied

The Libor scandal may have been an exotic distant anecdote for New Zealand's investment community, but the rate-rigging and fraud unmasked in major financial centres such as London, Frankfurt and New York has led to reform of our own interest rate benchmarks.

The Reserve Bank of New Zealand says it supports its official cash rate being used as New Zealand's fall-back benchmark interest rate.

"Global interest rate benchmarks, such as Libor, play a substantial role in the valuation of financial derivatives and contracts," RBNZ assistant governor Christian Hawkesby said in a statement.

"Reforms are underway to improve the integrity of these benchmarks following manipulation by several financial institutions overseas," Hawkesby said.

The standard benchmark used in New Zealand has been the 90-day bank bill rate, or bank bill market - BKBM.

"While New Zealand's benchmark interest rate has not faced these issues, the New Zealand Financial Markets Association has made a number of changes to further improve the benchmark's reliability and robustness, in line with developments in global best practice."

After consultation with industry representatives, the NZFMA has selected the OCR to act as the risk-free fall-back benchmark interest rate, Hawkesby said.

"In the first quarter of 2020, the International Swaps and Derivatives Association will be updating its 2006 fall-back provisions. Following this, it would be prudent for market participants to adopt them in contracts that reference BKBM," he said.

ISDA has appointed Bloomberg Index Services to calculate and publish relevant details related to the fall-back benchmark rate, should it be needed.

"Furthermore, the NZFMA has advised that it intends to operate dual interest rate benchmarks, retaining BKBM and developing risk-free rates," Hawkesby said.

Paul Atmore, chief executive of NZFMA, said his organisation believed BKBM would continue to be an important financial benchmark but that the use of risk-free rates will increase in line with international developments.

The scandal around the London Inter-Bank Offered Rate, the rate at which banks lent unsecured funds to each other and a benchmark used in myriads of financial contracts from managed funds and derivatives trading to consumer and business loans, began to emerge in 2012.

Regulators in Britain, the United States and European Union discovered a raft of supposedly reputable banking institutions from Barclays to Deutsche Bank and Rabobank had been rigging Libor for profit for many years.

These institutions had to pay more than US$9 billion ($13.7b) in fines and some individual traders were jailed, notably Tom Hayes, who had worked for UBS and Citigroup and who was sentenced to 14 years in prison, reduced to 11 years on appeal.

Such was the extent of the stink that Britain's Financial Conduct Authority took over calculation of Libor, which is actually a series of different interest rates, from the British Bankers Association. It will be replaced in 2021.

The New York Federal Reserve launched a possible Libor replacement in 2018, the Secured Overnight Financing Rate or Sofr.

Hawkesby said market participants in New Zealand who have contracts referencing Libor should continue to prepare for the transition away from Libor by using alternative benchmarks and adopting more robust fall-back provisions.

"While some banks have made good progress, market participants need to accelerate efforts to ensure they are prepared for Libor cessation by the end of 2021."