South Africa’s benchmark interest rate, the Johannesburg Interbank Average Rate (JIBAR), is set to be replaced by a new index before the end of the year, promising significant changes and potential tax implications for market participants. 

The shift to the new SA Rand Overnight Index Average (ZARONIA) is expected to improve the reliability of financial benchmarks, potentially affecting the value of various financial products. 

Tax experts at PwC explained that this new rate will effectively become the backbone of countless financial instruments, from corporate loans to derivatives. 

These benchmark interest rates are critical in determining the cost of borrowing and the valuation of financial contracts. 

For decades, JIBAR has been the key benchmark interest rate in South Africa, with it being calculated based on the rates banks are willing to lend unsecured funds to each other. 

This methodology has come under increasing scrutiny in recent years as it is based on expert judgment and estimations rather than actual market transactions. 

As a result, it is highly vulnerable to manipulation and may not accurately reflect true market conditions. Banks have also greatly reduced interbank unsecured lending, making it harder to calculate rates like JIBAR. 

PwC said banks could potentially influence their submissions to reflect more favourable borrowing rates, distorting the true cost of borrowing and lending.  

This manipulation was most evident during the early 2000s and became glaring during the global financial crisis, when banks reported borrowing at misleadingly lower rates, thereby masking their financial instability.

ZARONIA, in comparison, doesn’t face this issue as it is calculated based on actual overnight transactions in the wholesale funds market, making it a more reliable reference rate. 

By reflecting the actual cost of borrowing on an overnight basis, ZARONIA offers a stable and transparent measure that aligns with international standards for risk-free rates. 

This means that ZARONIA will be the recommended alternative reference rate for rand-denominated financial contracts going forward.

The implications

While the shift to ZARONIA should inspire greater confidence in South Africa’s financial markets and make them more transparent, it does come with significant changes and potential disruption. 

Its predecessor, JIBAR, was implemented in 1999 and has been used in the calculations of interest payments on loans, derivatives, bonds, and financial transactions.

“The move from JIBAR, a term rate incorporating a risk premium, to ZARONIA necessitates modifications to existing financial instruments,” PwC’s experts said. 

“These changes, while anticipated to be minor, maintain the original economic substances of transactions, raise related tax questions that impact both corporate and individual taxpayers.” 

ZARONIA, unlike JIBAR, is a near-risk-free rate. It lacks the built-in credit and term premium components of its predecessor, resulting in a generally lower rate compared to JIBAR. 

PwC said that the tax implications are still being debated within the tax industry and will hinge on how various factors are interpreted and applied. 

South Africans are unlikely to feel a significant impact from the tax implications, with the main effect on ordinary individuals being from the pricing of financial products tied to the new benchmark rate. 

This shift may alter pricing dynamics and change the price of financial products tied to JIBAR, creating disruptions for financial institutions, corporations and individuals with existing contracts. 

As a result, institutions or individuals could face liquidity issues and other challenges in managing their risk exposures, hedging strategies, and capital requirements.

Entities with existing JIBAR-linked contracts will need to review and potentially renegotiate terms to incorporate ZARONIA. 

Financial institutions must also assess and upgrade their systems to accommodate ZARONIA. This includes updating valuation models, risk management frameworks, and reporting mechanisms. 

Under the new reference rate, institutions will also need to reevaluate risk exposures, hedging strategies, and capital requirements.

This could lead to significant changes in the price of financial products offered to South Africans and the repayment terms.