All financial institutions in Switzerland are preparing to discontinue LIBOR, along with the United Kingdom, Japan, the United States and other countries, in favour of alternative reference rates. On 5 March 2021, the Financial Conduct Authority (FCA) announced the cessation of CHF LIBOR as of 31 December 2021. The Swiss national working group recommended using SARON (Swiss Average Rate Overnight) as an alternative reference rate in CHF.
Now, a new SARON mortgage is available at CA next bank. Who are these mortgages suitable for? How do they work? How are they different to LIBOR?
You will find below answers to the most frequently asked questions:
SARON mortgages are similar to CHF LIBOR mortgages in that they are suitable for clients who can accept uncertainties and fluctuations in the market interest rate and who wish to follow the rate changes for the duration of the chosen period.
It is based on the SARON 3-month compound rate, i.e. for the calendar quarters January to March, April to June, July to September, and October to December. The mortgage can apply for periods of two years, after which you can choose to either renew your contract at SARON rates, or switch to a fixed rate for the periods available in our fixed-rate range.
The definition of the interest rate that is applied is similar to that of a loan based on CHF LIBOR: “SARON 3-month compound rate (minimum 0)” + “Margin”. Margins may differ from one client to another, depending on their situation.
This product replaces our CHF LIBOR and variable-rate mortgages.
LIBOR (London InterBank Offered Rate) is a benchmark that measures the cost of unsecured short-term wholesale borrowing, calculated and published on the basis of bids submitted by a group of banks. LIBOR rates are published daily for different maturities (e.g. 1, 3, 6 and 12 months) and are known at the beginning of the interest period.
SARON represents the overnight dinterest rate of the secured money market for the Swiss franc. It is calculated on the basis of quotes and market transactions, weighted by volume. It is therefore more transparent and almost impossible to manipulate.
Unlike CHF LIBOR, which is reported for a range of different maturities, SARON is an overnight rate. Therefore, it cannot be used as such for loans, but must be “compounded” to calculate rates for longer periods.
For example, the SARON 3-month compound rate is calculated on the basis of the SARON overnight rates over the 3-month period (compound rate) and is only known at the end of the period when the SARON rate for the last day of the observation period is finally made available. This is a major difference with CHF LIBOR, which is known at the beginning of the period.
Historically, SARON and 3-month CHF LIBOR have evolved at similar levels (the % values since the end of 2013 are given below)
Below is a (theoretical) example of a mortgage based on the 3-month LIBOR with a margin of 1%: the value of the 3-MONTH CHF LIBOR on the fixing date is used to calculate the applicable client rate for the entire duration of the following quarter.
Thus, as the base rate (3-MONTH CHF LIBOR) was negative at 30/09/2020, the client rate is 1% for the 4th quarter of 2020.
If the 3-MONTH LIBOR rate were to move into positive territory (here with a hypothetical value of 0.3% at 31/12/2020), the client rate for the 1st quarter of 2021 would be 1.3%, and this value is irrespective of changes to the 3-MONTH LIBOR during the 1st quarter of 2021.
Below is a (theoretical) example of a mortgage based on the SARON 3-month compound rate with a margin of 1%: the SARON overnight rates for each day of the quarter (not just the last day of the quarter) are used to calculate the applicable client rate for the entire duration of the respective quarter*.
Thus, as the SARON overnight rates were negative throughout the quarter ending 30/09/2020, the SARON 3-month compound rate is negative and the client rate would have been 1% for the 3rd quarter of 2020*.
More generally, as long as the SARON 3-month compound rate remains negative, the client rate for the respective 3-month period would be equal to 1%.
If the SARON overnight rate were to move into positive territory (here with a hypothetical value of 0.3% at 31/12/2020), the client rate would not necessarily be 1.3% for the 1st quarter of 2021.
The SARON overnight rate will continue to be observed throughout the quarter (up to 5 days before the end of the quarter*), allowing the calculation of a SARON 3-month compound rate which could have:
- a (hypothetical) value of 0.6% at the end of March, in which case the client rate would be 1.6% for the 1st quarter of 2021 (graph below left),
- a (hypothetical) value of 0.25% at the end of March, in which case the client rate would be 1.25% for the 1st quarter of 2021 (graph below right).
*for operational reasons, the Bank will apply a time lag of 5 days between the observation period of the SARON overnight rates and the client interest period
All clients with LIBOR-based mortgages are contacted by the Bank with a view to converting them to a SARON 3-month compound mortgage or, failing that, a fixed-rate loan.
Please contact your advisor if you would like to change your loan agreement, or simply if you have any questions.