SARB Interest Rate Benchmarks: Over the last 3 years, banks across the globe have been planning and adjusting to the introduction of new Risk-Free Rates (RFRs) such as USD SOFR, EUR ESTR, and GBP SONIA. The effects of RFR reform are far-reaching, with impacts on derivative contract pricing and hedging, as well as tax and accounting implications.

The RFR reform is definitively underway in South Africa. Recently, attention has been turned to the next step of the reform process – ZAR interest rates. At the end of November 2021, the South African Reserve Bank (SARB) published a report titled “Feedback on the draft statement of methodology and policies governing the SARB-administered interest rate benchmarks.” This draft report summarises the public feedback of the Technical Specification Paper (TSP), which contains detailed calculation methodologies, contingency arrangements, and policies for new interest rate benchmarks in South Africa. These benchmarks include:

• South African Rand Interbank Overnight Rate (ZARIBOR),
• South African Secured Overnight Financing Rate (ZASFR),
• South African Rand Overnight Index Average (ZARONIA),
• Term Wholesale Financial Corporate Fixed Deposit Benchmark Rate, and
• Term Wholesale Non-Financial Corporate Fixed Deposit Benchmark Rate.

As part of the TSP, a back testing exercise for the benchmarks was conducted. Transactional data spanning five years was collected by the SARB from the JSE and the largest four commercial banks in South Africa. The exercise has two main objectives:

• Observing how historical benchmark rates behave over time and the appropriateness of the parameters used in the calculations, and
• Testing whether the contingency arrangements for each benchmark are adequate for events when calculations using the normal methodologies is impossible.

A few key takeaways follow from the feedback process on the TSP.

As expected, liquidity is an ever-present problem in an emerging market. In particular, it makes a true secured RFR such as ZASFR unfeasible. Hence, we have ZARONIA, an unsecured overnight rate which contains an element of credit risk, designated as the preferred successor to JIBAR. Note that to the extent that the feedback on the draft TSP influences the design of ZARONIA, these outcomes will inform further deliberations of the preferred JIBAR replacement.

The calculation methodology for the benchmarks requires the aggregation of transactions that share the same deal rate, allowing them to be ranked and for the top and bottom 10% to be trimmed off. The aggregation results in a dramatic drop off from 1000 average daily transactions to around 40 average daily transactions, and likely underestimates the true level of daily transaction volume. The back-testing exercise shows that even after the aggregation process, the market still demonstrates sufficient liquidity on average to support ZARONIA as an observable rate (and to not have to resort to a fallback).

A potential cause for concern, however, is that one bank tended to consistently make up over 50% of transaction volume in the unsecured overnight deposit market each day. This highlights market concentration as a risk to monitor closely.

Following this feedback process, some of the issues raised are being addressed. A final TSP will then be published after all feedback has been incorporated and is expected to coincide with the beginning of the observation period for ZARONIA.

Authors: Benard Vambe and Nicholas Petersen

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