Bye bye LIBOR – Hello SARON!
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Until now, banks have used LIBOR primarily to set the interest rates on loans and mortgages of the same name. However, it is now only supported by the British Financial Markets Authority until the end of 2021. This means that alternatives are needed. In Switzerland, this is the SARON. This reference interest rate is based on actual transactions and pricing in the Swiss money market.
Until now, banks have lent money to each other at LIBOR rates. However, these rates not based on actual transactions, but on agreements between eleven to 16 London banks. These banks then set the interest rate for different currencies (CHF, EUR, GBP, JPY and USD) and time periods. This makes LIBOR susceptible to manipulation, because the interest rates are usually based only on estimates by the participating banks. In 2011, it was discovered that LIBOR had apparently been manipulated by illicit collusion between some of the banks for years to their advantage. The discovery of the manipulations by possibly up to 20 major banks led to the LIBOR scandal. As a result, the key interest rate lost its reputation and legitimacy. The British Financial Services Authority has therefore decided to enforce its existence until the end of 2021.
The national working group on reference interest rates (Link wie in DE) has recommended that LIBOR be replaced by SARON. The SARON has been calculated and published by the Swiss stock exchange operator SIX Swiss Exchange since 2009. The average interest rate is calculated daily on the basis of around 110 completed transactions and tradable prices (quotes) from more than 160 banks (including the Swiss National Bank) and insurance companies in the Swiss money market.
The daily Saron rate can be found on the SIX website (Link wie in DE).
The SARON is determined daily on the basis of transactions and quotes executed. It is thus much more transparent, fair and - in contrast to LIBOR - can hardly be manipulated.
The SARON is an overnight rate, which means that it is only determined for one day at a time. For money market mortgages longer-term contracts are necessary . The Libor, in turn, includes fixed interest rates for three, six or twelve months. Nevertheless, the two rates have remained at the same level in recent years and have only deviated from each other by one to two basis points. In addition, the Swiss National Bank's working group has devised a solution for a long-term SARON. There are seven different versions available to financial institutions. They can choose which long term version of the interest rate they wish to use. For six of the variations, the Compounded SARON is calculated.
The Compounded SARON is a is calculated from a sequence of the one-day SARON. Depending on the version, a different number of one-day SARON are included in the calculation. In addition, the announcement of the interest rate/interest maturity takes place at different times depending on the version.
With the switch to SARON, it will become the reference interest rate for financing on the Swiss money market. This means that, as of January 2022 latest, the interest rate commitment will be decoupled from the capital commitment. The capital commitment will remain in place, but the interest rate commitment will be removed. The interest rate can only be calculated at the end of the interest period and will only be announced at that time. The interest rate risk for SARON is daily and not periodic as for LIBOR.
As a result of the change, LIBOR financing that extends beyond 2021 must be converted into an alternative product by the end of 2021.
The SARON mortgage is also expected to replace the LIBOR mortgage in the mortgage market by the end of 2021 at the latest. Many banks already offer corresponding mortgages. The development of SARON and LIBOR rates have been very similar in the past years. Because SARON operates on the secured money market, it has a more risk-neutral yield curve and less pronounced swings. This is probably due to its much broader-based calculation method. Moreover, SARON is published every 10 minutes, while LIBOR is only fixed once a day.
This means that hardly anything changes for the property owner. With SARON, they still have to assess the risk of interest rate fluctuations and interest rate trends in order to consider whether a fixed-rate mortgage with a long-term horizon is more secure than a SARON mortgage whose interest rate is subject to short term market fluctuations.
Do you have questions about the implications for your business or your mortgages? Then please contact Nicola Edelmann. He will be happy to help you along.
