ASX to launch overnight repo funding rate

The Australian Securities Exchange (ASX) is bringing to life a new interest rate benchmark next week to accommodate the strong growth in the domestic repo market, alongside the continuous reliance on existing rates for funding, lending, derivatives and risk management among institutional investors.

The Secured Overnight Funding Index Australia (SOFIA) measures the cost of overnight funding secured against high-quality Australian dollar-denominated government securities, based on eligible overnight repo transactions settled through Austraclear on the prior business day, the ASX said.

Eligible collateral includes government securities, semi-government securities, Treasury notes, and indexed bonds, as defined under general collateral 1 (GC1) in the AFMA Repo Conventions.

The ASX said the domestic repo market has grown "significantly" and is becoming increasingly important for secured funding and liquidity, with the evolution remaining consistent with global benchmark developments.

SOFIA was developed to meet the need to provide additional transparency and choice across funding markets, complementing the long-relied upon Bank Bill Swap Rate (BBSW) and Australian Overnight Index Average (AONIA) as core reference rates for funding, lending, derivatives, and risk management, the exchange said.

"Together, BBSW, SOFIA and AONIA provide market participants with a broader benchmark toolkit across unsecured, secured, credit-sensitive and risk-free markets," it said.

Fixed income specialist FIIG Securities head of research Philip Brown noted the introduction is a further step in the development of Australia's financial ecosystem.

"But it's a step designed to help the institutional players understand what's going on in the market, mostly in the market for shorter-term government bonds," he said.

He explained SOFIA will be tracking the repo rate which comprises almost zero risk because the loan is backed up by collateral in the form of a government bond, representing the risk involved as a credit risk of the government, not the borrowing institution.

"The reason there is no risk is the loan is backed up by collateral in the form of a government bond. This means that when one bank is lending money to another bank, the risk involved is not the credit risk of the borrowing bank, but rather the credit risk of the government itself," he explained.

"It's not quite zero risk, since even governments occasionally fail, but it is incredibly low risk."

He also highlighted the launch follows a long period where Australia had become an "outlier".

"Following the Global Financial Crisis many countries around the world shifted from using bank bill ratesets (like LIBOR and BBSW) to using repo-based ratesets for their swap markets," he said.

"At the time, the Australian system decided not to shift fully way from BBSW in part because the liquidity in the Australian repo market was comparatively poor compared to other countries. Australia has been an outlier in that we didn't use a repo-based rate for our swap markets."

However, the repo market has since developed significantly, and he believes SOFIA will create a new benchmark for international risk management by allowing easier switches from Australian risk to other currencies.

"For investors in direct bonds there is very little practical application. Real-money bond investors such as superannuation funds are very unlikely to participate in the repo market," he added.

"However, even the improvements on the institutional level do help the smaller participants as it's all part of the overall maturation and improvement of the Australian financial system.

"But it's that maturation and improvement that is bringing the big global players - like the recent Alphabet deal - into the Australian market. The more advanced and well-oiled the Australian system is the better it is for every participant, big and small."

Additionally, the bourse recently launched Australia's first exchange traded bond and credit index futures in collaboration with Bloomberg Indices, which aim to provide institutional investors an alternative avenue to manage exposure to the domestic fixed income market.