The switch from the global interest rate benchmark to its regional offspring, like SARON in Switzerland, represents a major challenge to financial institutions.
The London Interbank Offered Rate (LIBOR) has been in regular use as a financial benchmark rate since its launch in 1986. It is a major interest rate benchmark which underpins more than $300tn of financial contracts, including derivatives, bonds and loans. However, since the financial crises its 'panel-based' calculation method and its multiple uses have been under scrutiny. As the number of LIBOR transactions has reduced globally, the UK’s financial Conduct Authority (FCA) announced that it would no longer expect financial organisations to participate in LIBOR after 2021. As a result, different market regulators have prepared alternative references resulting in Switzerland creating the Swiss Average Rate Overnight (SARON).
The impact on financial institutions
The LIBOR transition has a significant impact on financial operations, for which financial institutions should be prepared by now. The transition to alternative rates will affect how contracts are written and priced, how products are designed and how risks are managed. The transition also had to be communicated to retail and wealth clients to position SARON as the new reference interest rate, e.g. for the popular variable mortgages, ensuring clients understand both changes to existing contracts as well as the new replacement products.
“Given the degree of uncertainty and complexity, LIBOR transition is likely to be one of the (if not the) biggest transformation programmes many firms have undertaken.” – Deloitte, 2019
There is no simple solution to replacing LIBOR with alternative reference rates. The new reference rates clearly require solutions that handle a range of compliant interest calculation methods, as well as a range of time periods and date conventions. However, the choice of rate and its implementation strategy can have a significant impact on products and processes throughout the financial enterprise. For example, unlike LIBOR rates, SARON is backward-looking for interest fixing and so consideration had to be given to how to implement and communicate rates for products that have traditionally been based on forward-looking basis.
How Avaloq prepared its clients for SARON
Avaloq has been active from the beginning in ensuring our clients have a smooth transition from LIBOR to SARON. We know that with any change comes great uncertainty, especially when considering the potential conduct, reputational and legal risk facing banks and wealth managers. Therefore, Avaloq has ensured our clients with system readiness to replace LIBOR with alternative interest rates as soon as possible.
As an example, new mortgages have already met the transformation period. Due to lowering mortgage rates, new home buyers have already chosen SARON mortgages putting pressure on lenders to meet regulatory and compliant expectations on time to benefit financially. For Avaloq’s client’s offering mortgages, there have been no issues and we are on track to ensure all our clients are able to leverage SARON on time.
The global replacement of the LIBOR as an interest benchmark provided another example how Avaloq generates value at scale for its clients. While the sheer complexity of the transition had the potential to overwhelm the capabilities of many banks, the Avaloq community could resort to a ready to implement solution and compete with new SARON products from the very start.