Bank Bill Benchmark Rate (BKBM)

What is a Bank Bill Benchmark Rate?

The Bank Bill Benchmark Rate (BKBM) is a critical interest rate benchmark in New Zealand's financial market. It is primarily used to reflect the supply and demand for bank bills. Market participants utilize the BKBM to calculate amounts payable under various financial instruments, such as reverse convertible notes, convertible bonds, and high-yield bonds.

BKBM plays a crucial role in determining the initial investment and initial pricing for these instruments. It is also instrumental in calculating interest payments for reverse convertible securities and other fixed-income investments. The rate impacts the valuation of underlying assets and underlying securities, thereby influencing stock prices.

BKBM is pivotal in the secondary market as it helps assess principal and interest payments for reverse convertible bonds and exchangeable securities. Financial institutions rely on this rate to offer higher yields on reverse convertibles and to set coupon payments on a monthly or quarterly basis. The maturity date and principal payment of these instruments are often linked to the BKBM, making it essential for investment decisions and tax purposes.

Benchmarks

Benchmarks, as defined by the International Organization of Securities Commissions (IOSCO), are critical components in the financial industry. They comprise prices, estimates, rates, indices, or values that are available to users either free of charge or for a fee. Benchmarks are calculated periodically, fully or partially by applying a formula or another calculation method to, or by assessing, the value of one or more underlying interests.

These benchmarks are used for various purposes, including determining the interest payable or other sums due under loan agreements or other financial contracts or instruments. They help establish the price at which a financial instrument, such as reverse convertible bonds or reverse convertible notes, may be bought, sold, traded, or redeemed. Benchmarks also play a crucial role in measuring the performance of financial instruments, such as convertible bonds and high-yield bonds.

Financial benchmarks are essential because they provide an objective measure of the prices, rates, or values to which they relate. These benchmarks are widely used to calculate the price or value of financial market transactions, significantly impacting the financial industry. For instance, the Bank Bill Benchmark Rate (BKBM) is a vital benchmark in New Zealand that influences the calculation of interest payments, principal payments, and the valuation of underlying assets in various financial instruments.

Significant value changes hands based on decisions made with reference to these benchmarks. For example, the BKBM affects the initial investment, initial price, and coupon payments of reverse convertible securities. Benchmarks are also used to assess financial value and guide decisions that impact the wider market, including the closing price and stock price of underlying securities.

Bank Bill Benchmark Rate Explained

The Bank Bill Benchmark Rate (BKBM) serves as a key interest rate benchmark in New Zealand, representing the mid-rates for Prime Bank-eligible securities traded in the local market. This benchmark reflects the rates at which banks are willing to borrow from or lend to one another for periods ranging from one to six months, including a credit premium over the comparable risk-free interest rate curve. This is crucial for determining interest payments on various financial instruments like reverse convertible notes and reverse convertible bonds.

BKBM is established using transaction-based data or executable bids and offers for one-, three-, and six-month tenors within a two-minute trading window held at 10:20 AM each business day. For two-, four-, and five-month tenors, the rate is set through interpolation. This method ensures that the BKBM accurately reflects the underlying assets and underlying securities involved in these transactions.

This rate is essential for calculating the initial investment and initial price of various financial instruments, including convertible bonds and reverse convertible securities. Market participants rely on BKBM to determine principal and interest payments, which are typically made on a monthly or quarterly basis. It also sets coupon payments and determines the maturity date of reverse convertibles and other debt instruments.

BKBM influences intraday pricing fluctuations of financial instruments, affecting the stock price of underlying stocks and underlying shares. This rate is crucial in the secondary market, where investors assess associated risks and potential higher yields of reverse convertible bonds.

Current Calculation Methods

The current calculation methods for Bank Bill Benchmark Rate (BKBM) involve the electronic capture of trade information, or executable bid and offer pricing, during a specific daily two-minute trading window. This process ensures that the BKBM accurately reflects the prevailing market conditions and the value of underlying assets.

Each business day at 10:20 AM, a two-minute trading window is used to gather data for the BKBM calculation. During this period, actual trades are recorded to capture the most accurate rates. If there are no trades, executable bids and offers are used instead. This method ensures the benchmark rate is representative of the market's willingness to lend or borrow for periods ranging from one to six months.

The precise capture of this data impacts the initial investment, initial price, and coupon payments of various financial instruments like reverse convertible notes and convertible bonds. By using transaction-based data or executable prices, the BKBM provides a reliable reference for determining interest payments and principal payments.

Rules and Protections for BKBM

The Bank Bill Benchmark Rate (BKBM) has several protective measures in place to maintain market integrity and ensure fair, accurate rate setting. All NZFMA members participating in the two-minute trading window must adhere to the NZFMA’s Reference Rate Operating Rules & Principles.

One key protection is the “no-gapping” rule, which requires participants to only move their bid or offer by one basis point (0.01%) at a time and allow sufficient time for the market to transact before entering a new bid or offer. This rule prevents significant shifts in the rate within the short two-minute trading window, ensuring stability and accuracy.

Additionally, participants must comply with rules requiring them to offer or accept a minimum number of lines of prime Bank Bill paper. Buyers must be capable of accepting Bank Bills issued by at least four different banks to place bids during the BKBM trading window. Sellers must be able to offer their own Bank Bills, and those who do not issue prime Bank Bills must offer at least three lines of prime Bank Bills. This requirement ensures minimum liquidity during the rate-setting window, reflecting all available market information and reducing the influence of any single trade on the final rate.

These protections are crucial for various financial instruments, such as reverse convertible notes, reverse convertible bonds, and reverse exchangeable securities. They ensure that the calculated BKBM rate accurately influences the initial share price, coupon rate, and coupon payments of these instruments. For instance, the stock price of the underlying stock is affected by the BKBM, impacting fixed-income investment decisions and the overall valuation of the underlying asset.

By maintaining these protections, the NZFMA helps safeguard the interests of investors and uphold the integrity of the financial market, ensuring that the BKBM remains a reliable benchmark for calculating interest payments and principal payments. This reliability is essential for making informed investment decisions and managing the risks associated with reverse convertible securities and other debt instruments.

Example

An example of a corporate bond with a yield linked to the Bank Bill Benchmark Rate (BKBM) is the Toyota Finance NZ, FRN 22oct2024. This floating rate note's interest payments are adjusted periodically based on the BKBM rate, impacting the coupon rate and ultimately the coupon payment that the investor receives. The bond provides an attractive fixed-income investment option as its yield fluctuates with the BKBM, offering potential upside appreciation while reflecting current market conditions. This linkage ensures that the bond remains competitive with other traditional corporate bonds and reverse convertible bonds in the market.