BBSW and Floating-Rate Bonds
The Bank Bill Swap Rate (BBSW) is an important metric in many markets including the bond and hybrid markets. It’s used as the floating-rate note (FRN) benchmark to determine periodic (most commonly quarterly) interest re-sets. It can also show the market’s expectation of future interest rates.
3-month BBSW as at 30 Sep 2019 : 0.950% (mid point, source ASX)
1. What is BBSW?
BBSW is a short-term money market benchmark interest rate. In general terms, BBSW is the average mid-rate at approximately 10.00 am for Prime Bank Eligible Securities with tenors of 1 to 6 months on a Sydney business day. Prime Bank Eligible Securities comprise bank accepted bills and negotiable certificates of deposit issued by banks that have met the eligibility criteria and conditions required to be a Prime Bank.
2. What is BBSW used for?
BBSW is used to provide reference interest rates for the pricing and revaluation of Australian dollar derivatives and securities such as floating rate bonds. BBSW is not directly linked to mortgage or other retail lending interest rates. Unlike UK and European interest rates such as LIBOR, Euribor and SIBOR, the only effect BBSW has on retail lending rates is via the general cost of funds, of which is it just one component.
3. How is BBSW calculated?
The BBSW rate represents the midpoint of the Nationally Observed Best Bid and Offer (NBBO) for Prime Bank Eligible Securities. The best bid and best offer are taken from a range of bids/offers electronically collected from approved trading venues at three intervals at and around 10:00am. The calculations are based on actual live and executable prices rather than observations of the traded market.
4. Who are the Prime Banks and how are they selected?
Current BBSW Prime Banks include Australia’s four major banks. A market survey is conducted annually to determine which banks will be afforded Prime Bank status. The survey, and the election process embodied within it, is designed to strike a balance between maintaining the quality of Prime Bank status and promoting market effectiveness and development by supporting a reasonably diverse range of Prime Banks.
To be eligible to become or remain a Prime Bank, a bank must:
- Be an authorised deposit taking institution (ADI) as defined by APRA
- Satisfy a credit rating benchmark – Standard & Poor’s short term rating of A1+ and a long term rating for senior unsecured debt obligations of at least AA
- Have securities eligible for use in the RBA’s open market operations and standing liquidity facilities.
5. Who is the BBSW administrator?
Effective 1 January 2017, ASX became the Bank Bill Swap (BBSW) rate administrator. Prior to this The Australian Financial Markets Association (AFMA) was the administrator. In early 2018, ASX introduced a new BBSW calculation methodology. It is based on actual transactions in Bank Bills (Bills) and Negotiable Certificates of Deposit (NCDs). The Volume Weighted Average Price (VWAP) methodology will support the recommendation of the Council of Financial Regulators and is consistent with IOSCO Principles for Financial Benchmarks.
6. Where can I find the latest BBSW rates?
The ASX website has a page including the latest BBSW rates. This page is updated daily (trading days only). The page also includes:
- A BBSW 10-day history report, and a
- BBSW volume report.
How does BBSW affect bonds?
Unlike fixed-rate bonds, which pay a fixed rate of interest, floating-rate bonds have a variable rate that resets periodically. Typically, the rates track the 90-Day Bank Bill Swap Rate (BBSW) which rises (and falls) roughly in-line with official interest rates. Floating-rate bond coupons are usually based on BBSW plus an added “spread” known as the Initial Margin. These details can be found for floating-rate XTBs on our Available XTBs table.
Example of an FRN
- A floating-rate note is issued with a face value of $100. It is issued for 3 years with a coupon of ‘3‐month BBSW + a margin, for example 1%’. This means coupon payments will increase if the benchmark 3-month BBSW rate rises, or decrease if it falls.
- 3-month BBSW currently stands at 1.00% (6 Sep). So, the rate for this example FRN would be 2.00% in the current coupon period. While the yield changes throughout the life of the security as prevailing interest rates fluctuate, the Initial Margin (the “1%” in the example above) stays the same. Latest BBSW rates can be found here.
- If the price of an FRN is above $100 the investor may get a return less than BBSW + initial margin. If the price is below $100 they may get a return more than BBSW + initial margin.
- For floating-rate bonds, the variable coupon has the effect of preserving the capital value of the bond in a rising interest rate environment.
Generating regular, predictable income with floating-rate bonds
A portfolio of just 3 floating-rate bonds can be structured with a coupon payment each month. This can offer investors a monthly, predictable income. The XTB Monthly Income portfolio could be the answer if you’re looking at floating-rate bonds and a monthly income appeals. The XTB Cash Flow Tool allows potential investors to check the cash flows you could receive from investing in a portfolio of XTBs. This allows you to check your expected return, BEFORE you make an investment decision. Check out the XTB Cash Flow Tool