Compliance with IOSCO Principles
Last Updated: 9 May 2016
The RBA has reviewed the methodology for the Interbank Overnight Cash Rate (Cash Rate) for compliance with IOSCO's Principles for Financial Benchmarks (the Principles). The Principles outline four elements: governance, quality of the benchmark, quality of the methodology and accountability. While the Principles state that benchmarks administered by a ‘National Authority’ for ‘public policy purposes’ are not within its scope, the RBA aims to adhere to the Principles where applicable, as they have been endorsed by the Financial Stability Board as being standards of best practice. The application of the Principles has been assessed in a manner that is proportional to the size and risks with regards to the nature of the benchmark, the administrator and the benchmark-setting process.
Table 1 provides a summary of the findings, followed by a detailed assessment of adherence to the Principles.
|1. Overall Responsibility of the Administrator||Observed|
|2. Oversight of Third Parties||Not Applicable|
|3. Conflicts of Interest for Administrators||Observed|
|4. Control Framework for Administrators||Observed|
|5. Internal Oversight||Observed|
|Quality of Benchmark|
|6. Benchmark Design||Observed|
|7. Data Sufficiency||Observed|
|8. Hierarchy of Data Inputs||Observed|
|9. Transparency of Benchmark Determinations||Observed|
|10. Periodic Review||Observed|
|Quality of Methodology|
|11. Content of the Methodology||Observed|
|12. Changes to the Methodology||Observed|
|14. Submitter Code of Conduct||Not Applicable|
|15. Internal Controls over Data Collection||Observed|
|16. Complaints Procedures||Observed|
|18. Audit Trail||Observed|
|19. Cooperation with Regulatory Authorities||Observed|
These principles require having arrangements to ‘protect the integrity of the benchmark determination process and to address conflicts of interest’. Overall, the RBA has observed the Principles set out in this section.
Principle 1 – Overall Responsibility of the Administrator
The administrator should retain primary responsibility for all aspects of the Benchmark determination process, e.g. development, determination and dissemination, operation, governance.
The administration of the Cash Rate is conducted by the RBA's Market Operations (MO) section in Domestic Markets Department (DM). Guidance for the section is given in the Cash Rate Procedures Manual (the Manual), which is available on the RBA website. It outlines the following responsibilities:
- collection and analysis of the source transaction data within RITS
- calculation and publication of the aggregated transaction data
- communication with cash market participants regarding any discrepancies
- implementing error handling policies
- periodically reviewing the data methodology and data inputs.
The Cash Rate Procedures Manual defines the Cash Rate as the weighted average interest rate of overnight unsecured lending between banks settled using RITS cash transfers.
To determine the Cash Rate, MO will receive data relating to each day's overnight unsecured lending transactions from RITS, which are flagged as relevant transactions by members of RITS. The data is then matched by an automated process in the Cash Rate system and any unmatched transactions are then investigated by MO staff, with any errors and/or mismatches followed up with the relevant bank. Once this is complete, MO calculates and publishes the Cash Rate on the following market data services: Reuters RBA30, Bloomberg RBAO7 and the RBA's website. This is usually done on the following business day (publication date).
Transparency of the data is provided in the publication of the:
- aggregate volume and number of cash market transactions
- highest and lowest interest rates reported
- range and average of volumes reported for individual cash market transactions.
There are set procedures when dealing with errors. That is, if an error is identified before 4pm on the publication date, the Cash Rate may be republished. If the decision to republish is made, the Reuters and Bloomberg pages will be marked with the flag ‘Republication’. However, if an error is found after 4pm on the publication date, the published Cash Rate at the time will not be revised. Every quarter, an error report will be published, listing each error in that period, whether each error led to a republication of the Cash Rate and the absolute change in the Cash Rate as a result.
The RBA has created the Cash Rate Oversight Committee (Oversight Committee) as a functional grouping to oversee the benchmark. The Oversight Committee follows a set Terms of Reference in its operation, including reviewing the benchmark and its control framework on a regular basis, the review of any complaints and whistle-blower reports, along with reviewing and endorsing reports from the annual DM audit.
Principle 2 – Oversight of Third Parties
The adoption by the Administrator (and its oversight function) of clearly defined written arrangements setting out the roles and obligations of the parties involved in the benchmark determination process and the monitoring of any third party's compliance.
This is not applicable as the RBA is the sole collector of inputs, calculator and publisher of the benchmark.
Principle 3 – Conflicts of Interest for Administrators
The documentation, implementation and enforcement of policies and procedures for the identification, disclosure, management, mitigation or avoidance of conflicts of interest.
The Cash Rate Procedures Manual outline the policies that the RBA has implemented to avoid conflicts of interest for those related to the setting of the Cash Rate. These include:
- RBA personnel must abide by the Code of Conduct for Reserve Bank Staff (RBA Code of Conduct), which requires them to recognise and manage any conflicts of interest between their personal interests and their responsibilities at the RBA.
- RBA personnel cannot enter into, arrange, buy, sell or otherwise deal in interest rate derivatives, or engage or be involved in active trading in any financial instrument.
- As per the Public Governance, Performance and Accountability Act 2013 (Cth), RBA personnel are required to disclose any material personal interest that relates to the affairs of the RBA.
- MO staff are subject to additional specific disclosure declarations.
Staff are required to review the RBA Code of Conduct every year to ensure they are familiar with its contents and are updated with any new provisions.
Principle 4 – Control Framework for Administrators
An appropriate control framework for the process of determining and distributing the benchmark.
Conflicts of interest are addressed as described above in Principle 3. Accountability and complaints mechanisms are described in Principles 16 to 19.
As mentioned earlier, the Cash Rate Procedures details a reconciliation process which MO undertakes after collecting data from RITS and prior to publishing the Cash Rate. This process involves checking the data so that there are a complete set of matching identifiers (IBOC1, IBOC2) on both sides of a RITS transfer. If this does not occur, the counterparty that withheld the identifier will be contacted, and asked to confirm their position. In addition, for a RITS transfer to be successfully put through, the interest rate field must be filled, which assists with the identification of overnight lending transactions and prevention of deliberate misstatements from counterparties.
The RBA has a publicly available Risk Management Policy, which forms the foundation for the RBA's policy for the management of the risks it faces. Under this framework, risks are assessed on an enterprise level (top-down) and a business level (bottom-up). The framework comprises several steps: the identification and analysis, evaluation, treatment, documentation and monitoring of risks. Individual groups and departments are responsible for identification and analysis of the risks in their areas and how to deal with them. There is oversight of the RBA's risk management practices from the Risk Management Committee, which meets at least six times a year.
The Cash Rate Procedures Manual states that RBA personnel who observe misconduct or irregularities with the Cash Rate determination process are required to report their concerns to an ‘Authorised Officer’, being one of the:
- Head of Human Resources;
- Assistant Governor (Business Services);
- Deputy Governor; or
In addition, any person directly involved in the Cash Rate determination process must follow specified procedures to inform DM senior management and the Oversight Committee in cases where manipulation, the attempt to manipulate, or collusion is suspected. An external reporting outlet is also available, in the form of ‘FairCall’ which is provided by KPMG. Concerns can be raised anonymously and are passed onto the Deputy Governor, who may then raise it with the Oversight Committee.
MO staff receive training so that they have the knowledge of, and are familiar with, the cash market and participants in that market, internal MO procedures, the Cash Rate Procedures Manual, AFMA's Cash Conventions and related internal reporting and escalation procedures. Staff competence is reviewed as part of the RBA's yearly performance evaluation cycles.
RBA staff must adhere to the RBA Code of Conduct, which prescribes rules surrounding conflicts of interest. Staff are also required to compete ethics training annually, and staff continuity training is also provided.
Principle 5 – Internal Oversight
An oversight function to review and provide challenge on all aspects of the benchmark determination process.
The Oversight Committee was formed to provide an oversight function for the Cash Rate determination process. A Terms of Reference document has been drawn up, which details the Oversight Committee's objectives, membership, governance, activities and responsibilities. This document is available to the public as an Annex to the Cash Rate Procedures Manual.
With regards to the oversight of the benchmark design, the Terms of Reference for the Oversight Committee state that it will ‘review the effectiveness of the Cash Rate benchmark and the related control framework on a regular basis’. In addition, the Oversight Committee will aim to be informed about issues and risks to the Cash Rate benchmark by ‘monitoring international trends in financial benchmarks and regulatory developments’. From this, the Oversight Committee can then make ‘recommendations to DM about the Cash Rate administration process or future development’.
It is also required that the oversight function considers the results of internal audits and oversees the implementation of audit recommendations; the Terms of Reference for the Oversight Committee details a ‘review and endorsement’ process for internal audits of the process. As per Principle 17, as the Cash Rate is a benchmark administered by a National Authority, there is no requirement for external audits.
Quality of the Benchmark
These principles require the ‘application of design factors’ to promote the quality and integrity of benchmark determinations. Overall, the Cash Rate arrangements complied with all the Principles within this category.
Principle 6 – Benchmark Design
The design should take into account generic design factors that are intended to result in a reliable representation of the economic realities and to eliminate factors that might result in a distortion.
The Principles describe five generic features that should be taken into account when designing the benchmark:
- adequacy of the sample
- size and liquidity of the relevant market
- relative size of the underlying market in relation to the volume of trading in the market
- the distribution of trading among market participants
- market dynamics.
The Cash Rate methodology only includes overnight unsecured cash lending that is settled through RITS. The average daily volume of lending conducted during the 2015 calendar year was almost $4.9 billion, compared to average surplus Exchange Settlement balances of $1.7 billion, meaning there is a substantial amount of turnover on a daily basis. While the major four banks make up a large proportion of the financial system, the distribution of trading amongst counterparties in the cash market is not dominated by the majors. For example, in calendar year 2015, the majors made up 50 per cent of total amounts borrowed and 25 per cent of total value lent. This indicates a significant volume of trading occurs with smaller banks.
Principle 7 – Data Sufficiency
Data used to construct a benchmark should be sufficient to accurately and reliably represent the interest measured by the benchmark, and should be based on rates that have been formed by the competitive forces of supply and demand and be anchored by observable transactions entered into at arm's length between buyers and sellers.
The data being collected represents the unsecured overnight cash market. As mentioned earlier, the interest rates entered by counterparties in RITS have to be matched before the cash transfer occurs. These rates are negotiated between counterparties as part of the overnight lending arrangements that they are entering into. Data is filtered to ensure that only arms-length transactions contribute to the benchmark. This is done through the use of an institutional relationships module that is built into the system, whereby a list of related ESA holders is kept, and any transactions through RITS which involves two related parties in that module are removed from the calculation.
Principle 8 – Hierarchy of Data Inputs
Guidelines regarding the hierarchy of data inputs and exercise of expert judgment should be established and made available.
The Cash Rate Procedures Manual refers to the Cash Rate being calculated from observed, valid cash market transactions recorded in RITS. The Manual states that if data are insufficiently robust, the Cash Rate target will be published. It gives an example of when this may occur: when there are insufficient or no cash market transactions. The Principles do not preclude the use of expert judgement in situations when there is low liquidity in a market.
Principle 9 – Transparency of Benchmark Determinations
Each benchmark determination should also include a concise explanation to facilitate an understanding of how the determination was developed, including, the size and liquidity of the market being assessed, the range and average of volume, range and average of price, indicative percentages of the type of market data used and the methodology. In addition, there should be a concise explanation of the extent to which and basis upon which expert judgement was used.
The Cash Rate Procedures Manual states that the aggregate volume and number of cash market transactions will be published, alongside the highest and lowest interest rates observed and the range and average of volumes for individual cash market transactions. This will be published by 11:30am on the publication date. Where the Cash Rate target has been used, as in situations mentioned earlier, this will be clearly highlighted, with the following annotation: ‘Cash Rate determined by reference to Cash Rate Target – Insufficient Data (or) Technical Problem’.
Principle 10 – Periodic Review
A periodic review of the conditions in the underlying interest to assess whether there have been structural changes to the interest that might require changes to the design of the methodology. A review should also assess whether the interest has diminished or is non-functioning, if so, the interest may not be a basis for a credible benchmark. Any reviews where material revisions have been made should be made available, with the justification of any material revisions.
The Cash Rate Procedures Manual states that periodic reviews of conditions surrounding the Cash Rate will be undertaken, with a view to possibly changing the methodology if there are ‘any structural or significant changes’. The Manual also mentions that such reviews will also look into whether trading activity and liquidity conditions in the market have deteriorated or diminished in such a way which would make the cash market an unviable basis for calculating the Cash Rate. Any reviews will then be reported to the Oversight Committee. If the Oversight Committee instructs DM to change the methodology, a summary of the revisions will be made available, including the rationale for these changes and intended implementation dates.
Quality of the Methodology
These principles set out the minimum level of information that should be addressed and published to enable stakeholders to understand and form their own views about the credibility of the benchmark. There should also be procedures relating to alerting stakeholders when material changes occur. The methodology follows the Principles set out in this section, but due to benchmark being the operational target for monetary policy, and the need to maintain flexibility around changes to the benchmark, the RBA has adopted a proportional response to Principles 12 and 13.
Principle 11 – Content of the Methodology
The methodology should be documented and published. The rationale for adopting a particular methodology should be provided.
This Principle highlights a number of minimum requirements for a benchmark's methodology; compliant measures are listed below:
- A definitions list of key terms is included in the Cash Rate Procedures Manual under the Glossary.
The Cash Rate Procedures Manual contains a section on the inputs to the Cash Rate
determination process. As mentioned earlier, the benchmark only includes transactions that
are overnight and unsecured, which have been processed through RITS. The Manual also states
that the following transactions are eliminated from the calculation process:
- transactions between banks conducted outside of RITS
- transactions with non-bank ADIs
- transactions with banks that use a settlement agent for all transactions across ESAs
- transactions between ESA holders that are ‘related bodies corporate’ (as defined in the Corporations Act 2001 (Cth)). For example, transactions between two subsidiaries of an entity or between an Australian branch of an entity and its subsidiary
- transactions in which the commitment to lend (or accept) funds was made in advance of the Report Date or included a commitment to lend (or accept) further funds on future days; and
- transactions in which the terms of the interbank loan were negotiated as part of a broader agreement that included other obligations between the two parties.
- The Cash Rate Procedures Manual prescribes that when data collected are determined to be ‘insufficiently robust’, the Cash Rate target is to be used. The Manual states that this can occur due to insufficient or no transactions being identified on the report date, or where the Administrator determines that reporting banks are not sufficiently complying with the transaction input requirements, or where the RBA's systems are unavailable to perform the calculation process. In all such instances, MO will escalate the decision to use expert judgment to the Head of DM or the Assistant Governor (Financial Markets).
An error report will be made publicly available every quarter, with an entry for each
instance when there is an intraday republication, an error with a published Cash Rate, or
when transactions were removed from the dataset. This will detail:
- the number of errors over the quarter and the date of each error
- whether each of these errors led to an intraday republication of the Cash Rate
- whether the error was made by a market participant or the RBA
- the absolute change in the Cash Rate as a result of the error
- the number of transactions removed from the calculation of the Cash Rate by the RBA.
Market participants will not be directly identified in the report. The Oversight Committee will review the report on a quarterly basis.
As mentioned earlier, a revision to the benchmark could arise if an error is found before 4pm on the publication date. If a revision is made, the new figure will be flagged with the term ‘Republication’. Any errors found after 4pm on the publication date will not result in a change to the published figure, but will nonetheless be included in the error report.
- The Cash Rate Procedures Manual states that internal reviews (as mentioned in Principle 10), will be conducted annually and will be approved by the Oversight Committee. As per Principle 17, benchmarks that are supervised by a National Authority are not required to be reviewed by an external auditor.
Principle 12 – Changes to the Methodology
The rationale of any proposed material change in its methodology and procedures for such changes should be published.
As mentioned in Principle 10, the Manual notes that DM will provide a ‘summary of revisions and intended implementation dates, and also publish the rationale for any such revisions’. As stated in Principles 5 and 10, the Oversight Committee is charged with regular reviews of the benchmark design and endorsement of the results of the yearly DM internal audit. The Cash Rate Procedures Manual states that any material changes to the Cash Rate methodology will be communicated to the market through the RBA's website.
Principle 13 – Transition
There should be written policies and procedures to address the need for the cessation of a benchmark.
The Cash Rate is the RBA's operational target for monetary policy. This necessitates flexibility around what sort of changes could be applied to the benchmark and how these changes are implemented.
Principle 14 –Submitter Code of Conduct
Not applicable, as the Cash Rate methodology is not based on submissions.
Principle 15 – Internal Controls over Data Collection
There should be appropriate internal controls over its data collection and transmission processes.
The data for the Cash Rate is solely collected from RITS and is stored in a system to assist DM in calculating the Cash Rate. As part of the reconciliation process, DM may amend the data so that mismatched observations are correctly accounted for in the system. Any side of a transaction that is added to the Cash Rate calculation or any observations that are taken out of the Cash Rate calculation require managerial approval. Access to the system and the transaction data it contains is highly restricted, with access only available to authorised users.
These outline the complaints procedures, documentation standards and audits that assist benchmark administrators in complying with the Principles and its own policies. Overall, the Cash Rate methodology follows the Principles' accountability requirements.
Principle 16 – Complaints Procedures
There should be a published written complaints policy regarding the representativeness of the benchmark, applications of the methodology and other Administrator decisions with regards to a determination.
The Cash Rate Procedures Manual states that internal complaints from RBA staff are handled under the Public Interest Disclosure Act 2013 (Cth). The Act requires complaints to be assessed within 14 days and if required, an outcome to be made within 90 days. Any complaints are required to be reported to one of four Authorised Officers:
- Head of Human Resources;
- Assistant Governor (Business Services);
- Deputy Governor; or
From there, the Oversight Committee will receive notice of the complaint and will then review and investigate it. While the Act only covers complaints from within the Commonwealth public sector, the Manual states that any external complaints will also be handled in a similar way to internal complaints, that is, in the first instance, contact should be made with an Authorised Officer, before escalation to the Oversight Committee. An email address is provided for this purpose. The Manual states that the Oversight Committee will process complaints on a timely and fair basis, and will inform the complainant of the outcome in a timely manner. Any relevant correspondence and documentation relating to these complaints will be retained permanently as per the Records Authority between the RBA and the National Archives of Australia. This is a requirement as these are considered significant records relating to the RBA's financial market operations.
Principle 17 – Audits
An internal or external auditor should be appointed to review and report on the Administrator's adherence to its own stated criteria and the Principles.
Annual DM audits of the Cash Rate calculation process will be conducted by the RBA's Internal Audit Department, the results of which are distributed to the Board's Audit Committee and the RBA's senior management. There will also be an annual review of the Cash Rate methodology against the Principles, which will be undertaken by the RBA's Risk and Compliance Department. Benchmarks administered by National Authorities are exempted from having to appoint an external auditor.
Principle 18 – Audit Trail
Written records should be retained by the Administrator for five years.
The Cash Rate Procedures Manual states that transactions designated as Cash Rate transactions will be retained permanently by the RBA as national archives, consistent with the aforementioned Records Authority.
Any transaction data that are not used as part of the Cash Rate calculation are deleted after seven months, while a log of changes to transaction data is maintained. This is compliant with the Principles as only data that was ‘relied upon for benchmark determination’ should be retained.
In addition, instances when expert judgement has been exercised, and hence any deviations from standard procedures, will be retained permanently. User stamps will be recorded alongside changes and calculations in the system.
Principle 19 – Cooperation with Regulatory Authorities
Any documents referred to by the Principles such as audit trails, should be made available to regulatory authorities.
The Cash Rate calculation process is not subject to regulatory oversight, but any external review by a regulator will have ready access to the relevant data or documentation.