Compliance with IOSCO Principles

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. This assessment was last conducted in December 2021.

Table 1 provides a summary of the findings, followed by a detailed assessment of adherence to the Principles.

Table 1: Summary of Findings

Principle	Assessment
Governance
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
13. Transition	Observed
14. Submitter Code of Conduct	Not Applicable
15. Internal Controls over Data Collection	Observed
Accountability
16. Complaints Procedures	Observed
17. Audits	Observed
18. Audit Trail	Observed
19. Cooperation with Regulatory Authorities	Observed

Governance

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.

The administration of the Cash Rate is conducted by the RBA's Monetary Policy Implementation (MPI) 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
• applying, where required, the use of expert judgement
• 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, MPI 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 are then matched by an automated process in the Cash Rate system and any unmatched transactions are then investigated by MPI staff, with any errors and/or mismatches followed up with the relevant bank. Once this is complete, MPI 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 through the publication of relevant summary statistics.

On a daily basis, the following is published:

• highest and lowest transaction rates
• aggregate volume of cash market transactions
• number of cash market transactions.

On a monthly basis, the following is published:

• average, highest and lowest transaction rates
• aggregate volume of cash market transactions
• number of 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, reviewing any complaints and whistle-blower reports, along with reviewing and endorsing reports from internal audits.

This is not applicable as the RBA is the sole collector of inputs, calculator and publisher of the benchmark.

The Cash Rate Procedures Manual outlines 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 for personal benefit.
• 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.
• MPI 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.

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 MPI 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. It sets out the RBA’s appetite for risk, and the operational framework to identify, evaluate and mitigate risks. Individual groups and departments are responsible for 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:

• Chief Risk Officer;
• Deputy Governor; or
• Governor.

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.

MPI staff receive training so that they have the knowledge of, and are familiar with, the cash market and participants in that market, internal MPI 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 business continuity training is also provided.

Under the RBA's Business Continuity Management Policy, the RBA will seek to ensure that its critical business functions can be maintained or restored in a timely way in the event of disruption. The RBA's Financial Markets Group maintains a documented Business Continuity Plan, which covers the timely calculation and publication of the Cash Rate. The Plan includes redundancy and failover of critical systems and staff relocation to a Business Recovery Site. These arrangements are regularly tested.

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 an ongoing 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 Procedures Manual or future development of the Cash Rate’.

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.

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 captures overnight unsecured cash lending that is settled through RITS. The average daily volume of lending conducted during the 2021 calendar year was $0.3 billion, compared to an average of $3.9 billion in 2019, prior to the expansion of the RBA's balance sheet and increase in Exchange Settlement balances. Average surplus Exchange Settlement balances were $225.6 billion in 2021. Although the volume of transactions has fallen significantly, the cash market remains active, albeit with very low liquidity. Transactions continue to occur among a range of borrowers and lenders in line with limited, but non-zero demand, for liquidity.

When activity falls below certain thresholds, the RBA applies Expert Judgement in determining the cash rate (see Principle 8). The lower volume of transactions since mid-2020 has led to the RBA using Expert Judgement more frequently; the Cash Rate was determined by Expert Judgement 190 times in 2021. The Cash Rate Procedures Manual outlines three options for Expert Judgement, providing certainty that the Cash Rate will be produced even in times of reduced market activity. The use of appropriate Expert Judgement when there is a low volume of transactions seeks to ensure the Cash Rate continues to represent economic realities.

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.

The Cash Rate Procedures Manual refers to the Cash Rate being calculated from observed, valid cash market transactions recorded in RITS. For the Cash Rate to be determined entirely from Cash Market Transactions, four criteria, including three market activity thresholds, are specified. These thresholds set the minimum volume of transactions, number of transactions, and number of unique counterparties required to determine the cash rate from market transactions.

The RBA uses Expert Judgement to determine the cash rate when one or more of these thresholds have not been met. The Cash Rate Procedures Manual also outlines the appropriate escalation of decision-making in these instances. Three options for the use of Expert Judgement are provided, with an indication of the sequence in which they apply and the factors considered. Additionally, the channels for communicating the use of Expert Judgment are outlined.

The Principles do not preclude the use of expert judgement in situations when there is low liquidity in a market.

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 for cash market transactions. This will be published by 9:20am on the publication date. Where a Cash Rate determined by Expert Judgement has been used, as in situations mentioned earlier, this will be clearly highlighted, with the following annotation: ‘Cash Rate determined by reference to fall back procedures – Insufficient Data (or) Technical Problem’. On days where Expert Judgement has been applied because one or both of the thresholds for number of transactions and number of participants have not been satisfied, less daily data are published to mitigate the risk of releasing commercially sensitive information. The RBA also publishes data on a monthly basis, including: average, highest and lowest transaction rates; and aggregate volume and number of transactions.

The Cash Rate Procedures Manual states that quarterly 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. If changes are made to 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.

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 outlines several circumstances where expert judgement will be used. In all such instances, the decision to use expert judgment will be escalated to the Deputy Head of DM or Head of DM.
• 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.

• As per Principle 17, benchmarks that are supervised by a National Authority are not required to be reviewed by an external auditor.

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.

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.

The Cash Rate Procedures Manual addresses the possibility of cessation. High-level procedures that would apply in the event that cessation is required are provided.

Not applicable, as the Cash Rate methodology is not based on submissions.

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.

Accountability

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.

The Cash Rate Procedures Manual includes a published policy for both internal and external complaints. Internal complaints channels include an employee's reporting line as well as alternative channels specific to fraud, unethical behaviour and conduct. External complaints channels include contacts for general enquiries about the RBA's activities, as well as the contact for an independent provider to which suspected illegal or unethical behaviour can be reported.

Regular 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 a periodic 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.

The Cash Rate Procedures Manual states that transactions designated as Cash Rate transactions will be retained permanently by the RBA as national archives per the Records Authority between the RBA and the National Archives of Australia.

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.

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.