Switzerland decommissioning LIBOR
With the London Inter-Bank Offered Rate (LIBOR) about to be phased out and replaced with SARON for the Swiss franc, banks and other financial institutions have a lot of work to do, very quickly. We take a first look at what’s involved and the reasons why you have to get started now.
How important is LIBOR for Switzerland?
More than 80% of CHF loans have LIBOR-based pricing , and 15-25% of CHF mortgages (USD 200 billion) and almost all exchange-traded derivatives and OTC contracts are LIBOR-based . Currently, LIBOR is the most widely used reference rate for USD, EUR, GBP, JPY, and CHF denominated products. Owing to the sparseness of transactions, however, LIBOR is known to be vulnerable to manipulation.
Impact of the replacements for LIBOR in Switzerland
The Financial Conduct Authority (FCA) will no longer support LIBOR from the end of 2021. For this reason, regulators are urging banks to prepare the transition to alternative rates. Financial services organizations – and not only banks – will have to transform many aspects of their business by then to comply with the post-LIBOR world.
For Swiss financial institutions, the focus is on the transition to SARON (Swiss Average Rate Overnight), which will take the CHF LIBOR’s place as the new Swiss standard. A SARON reference IRC (interest rate curve) is provided and calculated by SIX based on the prices of actual collateralized transactions with a daily trade volume of CHF 5 billion . This underlying liquidity, together with the application of filters to identify outliers, makes SARON significantly more robust and less at risk of manipulation than LIBOR.
While the preparation of alternative rates is under way in all markets, there has only been rather limited guidance from regulators to financial institutions on how to transition to a world without LIBOR. FINMA, for example, has provided some basic guidance regarding legal, valuation, and basis risk mitigation and operational readiness, and has launched a questionnaire to help Swiss banks assess the status of preparation. According to Handelszeitung  only 11% of the surveyed companies already have resources planned and are ready to change their organizations. It is estimated that the costs of the LIBOR transition may amount to CHF 400 million at a large bank .
The ICE Benchmark Administration (IBA) has been authorized by the FCA and LIBOR has been registered in ESMA’s register since April 27, 2018. On this basis, European Union supervised financial institutions can continue to use LIBOR. However (and as for all other benchmarks), they need to have in place and publish “robust written plans in setting out the actions that they would take in the event that a benchmark materially changes or ceases to be provided” (ref. Article 28(2) EU Benchmarks Regulation (EU) 2016/1011, BMR). HM Treasury is currently preparing the transposition of BMR into UK law to mitigate any adverse Brexit effects on benchmarks provided or supported by UK institutions.
Swiss financial institutions are not subject to similar regulation as users of benchmarks. However, FINMA has set a milestone for category 2 and 3 financial organizations to hand in a self-assessment of the status of their preparations to transition from LIBOR to alternative rates by April 30.
Considering the BMR deadlines and the guidance from FINMA and international supervisory authorities, financial institutions should ensure readiness for a post-LIBOR world as quickly as possible – especially in light of the following challenges:
- After the confirmation of the new SARON reference rate and once new contracts are ready, some of the old contracts due to mature after 2021 need to be converted to the post-LIBOR world (i.e. contain fallback clauses for alternative rates). The time and effort (including potential legal disputes) involved in amending contracts should not be underestimated.
- LIBOR is in use for five currencies. Alternative rates will be available at different points in time. Some of these reference rates are secured (like the Swiss SARON or the US SOFR [Secured Overnight Financing Rate]), while others are not (like the EUR ESTER [Euro Short-Term Rate]). This poses additional difficulties in replacing cross-currency swaps.
Another big challenge of replacing the LIBOR lies in the fact that it is a forward-looking reference available for different tenors. SARON is an overnight average of executed trades and therefore backward looking. There are different methods proposed by the national working group (NWG) using a compounded SARON 3M (to replace the LIBOR 3M) :
– Use a fixed rate contract if market participants have an aversion to variable future interest payments.
– Use an in-advance type product if a floating-rate product is preferred but the next cash flow must be known at the beginning of the period.
– If it is sufficient to know the cash flow close to the end of the period, an in-arrears option can be used.
However, the NWG clearly states that each market participant must consider and assess these options, and has not given any recommendation yet.
- Obviously, besides product amendments and contractual challenges, financial institutions face multiple operational and IT challenges on various levels to ensure a smooth transition of their business model to the post-LIBOR world and avoid major operational risks. Similar to the introduction of the euro, financial institutions will need to launch large transformation programs considering the impact on all areas of their organization, such as product management and control, trading, legal, capital and risk management, treasury, financial accounting and tax, IT and operations, etc.
We at Synpulse are looking into the challenges that this replacement will raise to enable us to work with our clients to resolve them. Following this first introductory article, we will be sharing more in-depth views of how to tackle the “beast” of replacing LIBOR. Follow us to get all the relevant updates!
- Swiss National Bank, The National Working Group on Swiss Franc Reference Rates," 2019. [Online]. Available: https://www.snb.ch/en/ifor/finmkt/fnmkt_benchm/id/finmkt_reformrates
- Financial Stability Board, "Reforming Major Interest Rate Benchmarks," 2014. [Online]. Available: http://www.fsb.org/wp-content/uploads/r_140722.pdf
- SIX Swiss Exchange, "Swiss Reference Rates," [Online]. Available: https://www.sixgroup.com/exchanges/indices/data_centre/swiss_reference_rates/reference_rates_en.html
Handelszeitung, "Saron statt Libor: Teure Umstellung mit Risiken," 23 November 2018. [Online]. Available:
- HM Treasury, "The Benchmarks (Amendment) (EU Exit) Regulations 2018: explanatory information," 8 January 2019. [Online]. Available: https://www.gov.uk/government/publications/draft-benchmarks-amendment-and-transitional-provision-eu-exit-regulations-2019/the-benchmarks-amendment-eu-exit-regulations-2018-explanatory-information.
- Swiss Statistics, "Gross Domestic Product," 2019. [Online]. Available: https://www.bfs.admin.ch/bfs/en/home/statistics/national-economy/national-accounts/gross-domestic-product.html.