With the shift on the money market from ‘funding against creditworthiness’ to ‘funding against collateral’ – and a manipulation scandal – the days of one of the most important figures on the financial markets are numbered. The LIBOR (London Interbank Offered Rate) will no longer be published after 2021, to be replaced in Switzerland by the Swiss Average Rate Overnight, or SARON. The SIX Swiss Exchange functions as the benchmark administrator and is responsible for calculating and publishing the figure.
Since its official introduction in 1986, LIBOR has served as the interest rate at which banks lend money to one another without collateral. However, because banks have had to offer collateral to borrow money almost without exception since the 2008 financial crisis, there are now very few such transactions. This means that LIBOR is calculated almost exclusively on the basis of expert estimates, which makes it susceptible to manipulation. One such manipulation scandal became public in 2012. Banks made agreements among themselves and manipulated LIBOR for their own gain.
Because of these problems, in Switzerland LIBOR will be replaced by SARON, which is more robust and representative and has a more transparent calculation method.
LIBOR vs. SARON – what are the differences?
In contrast to LIBOR – which is estimated on the basis of information provided by five to eight banks – SARON is calculated on the basis of completed transactions (average of around 160 interest rates daily). It is recalculated every 10 minutes, while LIBOR was only calculated once a day. This makes SARON more broad-based and impervious to manipulation. However, replacing LIBOR is extremely complex and involves operational risks.
Risks associated with the introduction of SARON
The switch to SARON involves a fundamental change to the financial infrastructure. Because of the high volume of LIBOR contracts, replacing LIBOR involves a risk per se. In general, it can be said that wherever interest rates are involved, LIBOR is affected. The impact on the credit business, risk and contract management and even IT should not be underestimated. For banks, the switch will affect a number of processes, contracts and systems.
How has the sector progressed with the introduction of SARON?
SARON has been available as an alternative to the CHF LIBOR since mid-2019. However, a survey conducted in June 2020 showed that there is still a total volume of more than CHF 2 trillion in financial instruments with a maturity after 2021 that are tied to LIBOR in Swiss francs. In fact, the total value of financial instruments in Switzerland that are tied to LIBOR is as at least CHF 14 trillion. The discontinuation of LIBOR at the end of 2021, including LIBOR in Swiss francs, therefore represents a significant operational risk.
As the expected date of the discontinuation of LIBOR approaches, pressure is rising to ensure an orderly transition from LIBOR to alternative rates. To date, there has been progress in the area of contract management, in particular, thanks to clauses which allow reversion to alternative interest rates.
The orderly transition to the SARON reference rate is part of FINMA’s supervisory focus for 2021. To this end, entities under supervision are being subjected to greater monitoring by FINMA in terms of the risks connected with the replacement of LIBOR. In order to achieve the aim of full operational readiness by the end of 2021 – i.e. the functioning of all systems and processes without dependence on LIBOR – it may make sense to modify project plans.