SARON: the replacement rate for CHF LIBOR

The Swiss Franc LIBOR rate (CHF LIBOR ) serves as the underlying interest rate for various financial products, such as bank accounts, mortgages or loans. In Austria it is predominantly used in relation to the foreign currency loans denominated in Swiss franc. However, as the CHF LIBOR is to be discontinued from 1 January 2022, at EU level a Regulation has been enacts that states that the SARON money market rate will replace the CHF LIBOR from the start of next year. This shall apply to all contracts and financial instruments within the EU , that currently use the CHF LIBOR as a reference rate, and which do not contain any contractual clauses, or only have inadequate ones addressing the discontinuation of the CHF LIBOR rate.

Due to differences in the calculating of the respective CHF LIBOR and SARON reference rates, the Regulation also contains some technical adjustments that are to be applied when calculating the respective SARON rate. How this is handled precisely is contained in Commission Implementing Regulation (EU) 2021/1847.

This rule about the legal successor to the CHF LIBOR was explicitly supported by the FMA and the OeNB in the interests of ensuring legal clarity.

Why only act now? Was it not possible to intervene earlier?

The European Commission has acted with great expediency in enacting the replacement rate for CHF LIBOR, with a view to affording stakeholders the greatest possible advance notice of the statutory replacement. The power to adopt a statutory replacement was granted to the European Commission only early in 2021, just before the UK’s Financial Conduct Authority (FCA ) confirmed the cessation of CHF LIBOR. The European Commission then launched a first targeted consultation on replacing CHF LIBOR in March 2021.

Why is there a replacement rate for CHF LIBOR (and not for JPY or GBP LIBOR, which are also ceasing)?

The European Commission’s powers to enact a statutory replacement for a non-EU benchmark that is ceasing are conditional on the economic impact the cessation of that benchmark would have in the European Union. The European Commission is only entitled to intervene where the cessation would significantly disrupt the functioning of financial markets in the EU or pose a systemic risk to the financial system in the EU. For CHF LIBOR, the European Commission has indications that there are a number of legacy contracts in several Member States that cannot be renegotiated before year’s end. Also, for JPY LIBOR and for GBP LIBOR , the UK Financial Conduct Authority has announced that it will compel the administrator of LIBOR to continue publishing the benchmark using an alternative, synthetic methodology for at least one year.

Why was this particular replacement rate chosen?

In accordance with the Benchmark Regulation, the European Commission has to take certain factors into account in designating a particular replacement rate. Notably, the recommendations made by the National Working Group on Swiss Franc reference rates are of importance. This private sector working group recommended both the use of SARON as a base rate for the replacement and the use of an adjustment spread to limit value transfer. On the basis of this initial proposal, the European Commission carried out two rounds of public consultation, which resulted in minor tweaks to the methodology chosen for the replacement rate. The end result is a rate which, for each of the maturities concerned, strikes a balance between being similar to the original rate and having an observation period which is close in time to the period to which the interest rate applies.

What about foreign currency mortgages?

The European Commission is aware that a significant portion of the contracts in the EU that reference CHF LIBOR are retail mortgages denominated in Swiss Francs. We understand that many of these contracts predate the current rules on retail mortgages. This implementing decision is not specific to those contracts and expresses no opinion about the appropriateness of concluding mortgage contracts denominated in the currency of a third country

What does this replacement rate mean for mortgage holders?

This replacement rate first and foremost means that mortgage contracts can continue to be performed, so it provides mortgage holders as well as the banks that granted those mortgages with legal certainty. To avoid significant value transfer, the replacement rate includes an adjustment spread that was set on 5 March 2021, the date when it was announced that CHF LIBOR would be discontinued. Any slight value transfer parties may see on 1 January 2022 would be a result of the rates’ respective movements since 5 March 2021.

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