AFMA Fallback Language Template for Floating Rate Notes

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The AFMA Fallback Language Template for Floating Rate Notes (FRN) is made publicly available for incorporation in FRN securities documentation as suggested template language to assist the market.

The context for the creation of the template language was the announcement [RBA Media Release 2021-20] on 13 September 2021 by Reserve Bank of Australia (RBA) that robust fallbacks are required for BBSW Securities. 

The RBA sets eligibility criteria for securities to be accepted as collateral in the Bank's market operations. Floating rate notes (FRNs) and marketed asset-backed securities issued on or after 1 December 2022 that reference BBSW must include robust fallback provisions.

All self-securitisations, regardless of the date of issue, must include robust fallback provisions. The RBA will engage directly with self-securitisation issuers and give at least 12 months' notice before enforcing this requirement.

Eligibility criteria for FRNs and marketed asset-backed securities issued before 1 December 2022 are unchanged. However, issuers should strongly consider including robust fallbacks for such securities, depending on their length of time to maturity, as a matter of prudent risk management.

Purpose of the Fallback Language

The fallback language is for market participants’ voluntary use in contracts that reference BBSW and a potentially substituted alternative rate and was developed with the goal of reducing the risk of serious market disruption in the event that BBSW is not available.

In response to weaknesses identified in the setting of benchmarks such as the London Interbank Offered Rates (LIBOR), the global regulatory community has been involved in a program to strengthen benchmarks. These requirements were introduced by the RBA as part of global reforms to strengthen financial benchmarks and ensure they are used appropriately in the financial system. Financial regulators globally have been urging market participants to make financial products more robust by including fallback provisions to apply if the referenced benchmark rate is discontinued.

Risk-free rates (or RFRs) are considered robust alternatives to LIBOR and similar rates. For the Australian dollar, the key interest rate benchmarks are the bank bill swap rates (BBSW) and the RBA’s Cash Rate. The RBA is the Administrator of the Australian financial benchmark known as the interbank overnight cash rate (Cash Rate). The RFR supported by the authorities for Australia is the RBA’s Cash Rate. Further information on the Cash Rate is provided by the RBA on its Cash Rate Procedures Manual webpage. Due to market practice and convention ‘AONIA’ is the term used by market participants, including in FRN securities documentation for the Cash Rate. AONIA means the same as the Cash Rate.

The Cash Rate is provided to other data service providers, including publication to the Bloomberg RBAO7 and Refinitiv RBA30 screen pages and is directly published by the RBA on its own website in the Statistical Table F1. These alternative publication sources are also authoritative. The Cash Rate / AONIA is the officially sanctioned alternative RFR for Australian dollar-based transactions. The Cash Rate is generally calculated by the RBA as the weighted average interest rate on overnight unsecured loans settled as Cash Transfers in the Reserve Bank Information and Transfer System (RITS) between banks in the Australian dollar Cash Market. The Cash Rate Procedures Manual describes the design of the Cash Rate benchmark and sets out the procedures that apply to the RBA for collecting and monitoring transaction data, how these data are used to calculate the Cash Rate, and the processes for publishing the Cash Rate, including where Cash Market Transactions may be insufficient.
AONIA through long market usage is commonly used in place of the term Cash Rate and has wide acceptance in financial instrument documentation. While AONIA had its origins as an acronym for “AUD Overnight Index Average”, inference should not be made that this is its current interpretation. This is because it is the same rate as the published RBA calculated Cash Rate. While this means that AONIA will generally be calculated using Cash Market Transactions there are circumstances, catered for in the RBA Cash Rate Procedures Manual, when there are insufficient transactions warranting the use of an alternative methodology.

It is the publication of the Cash Rate that determines AONIA for that day. This explains the emphasis on the singularity of AONIA and the Cash Rate and that it has no independent calculation methodology or characteristics.
Given the predominance of LIBOR reference rates across financial instrument documentation, any phase-out has major implications for the markets globally. Accordingly, the Australian market is preparing for the effects of this change.

Comment on the template language

The language consists of two operative provisions – Conditions [1.1] & [1.2] along with the Definition provisions. [Condition 1.2] provides a fallback waterfall in the event there might by a temporary disruption in the publication of the BBSW benchmark rate or a permanent discontinuation of the BBSW benchmark.

In simple terms, if there were to be a waterfall permanent discontinuation of the BBSW benchmark, which relies on a trigger event, the fallback is to AONIA to which a defined spread adjustment is applied.  In the remote possibility that AONIA were also to cease, the fallback is to the RBA Recommended Rate to which a spread adjustment can be applied. The RBA Recommended Rate would be the rate recommended by the RBA as an alternative to AONIA in the circumstances of the time. At the base there is accommodation for a Final Fallback Rate to be determined by a calculation agent.

The following diagram sets out the flow of the fallback provisions.