The international reform process so far and the importance of interest rate benchmarks from a central bank perspective
Dewet Moser, Alternate Member of the Governing Board of the Swiss National Bank
Joint Event SIX Swiss Exchange and SFAA Swiss Bond Commission, Zurich, 22.09.2017
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Credible and robust interest rate benchmarks are a cornerstone of modern financial markets. They improve price transparency and are used for derivative products. In Switzerland, the Swiss franc Libor is by far the dominant benchmark. For decades, the Libor-based swap-curve has represented the backbone for the pricing of loans, mortgages and bonds.
In 2012, however, Libor manipulations came to light. The UK regulator then triggered a long series of reforms. Two years later, the Financial Stability Board, charged with coordinating the reform efforts internationally, recommended pursuing a two-rate approach. On the one hand, existing unsecured rates like the Libor were to be strengthened. On the other, almost risk-free rates were to be developed. Accordingly, the governance structure of the Libor was significantly improved through various reforms. However, the credibility and robustness of a benchmark also depends critically on a liquid underlying market. As a consequence of the financial crisis, turnover in unsecured money market, the calculation basis for the Libor, had declined dramatically, and has not recovered since. Therefore, this July, the UK regulator announced that it would only support Libor until the end of 2021. This means that the very future of the Libor is in jeopardy. Fortunately, for most currencies, alternative rates are available. They are anchored in overnight money market transactions.
In Switzerland, one obvious alternative could be SARON, a benchmark for the Swiss franc repo market launched in 2009. The National Working Group is in charge of guiding the reform process and the likely shift away from the Libor. Given the heavy dependence of markets on the Libor, this will be quite a challenge. To succeed, all market participants must contribute to a smooth transition, in other words to prepare themselves in good time and act in a coordinated manner. The SNB will continue to guide the process, but in the end it is the responsibility of the private sector to choose an alternative and ensure a timely transition.
Credible and robust interest rate benchmarks are also relevant for monetary policy. Since benchmarks of this kind typically capture the level of short-term interest rates in a specific market segment, they are directly impacted by central banks' interest rate decisions. This means that benchmarks are transmitters of monetary impulses to financial markets and the broader economy. The more widely a given benchmark rate is used for pricing financial contracts, the more efficiently monetary impulses are transmitted. Furthermore, robust benchmarks increase the transparency with respect to the prevailing financial conditions.
Since late 1999, the Libor has been the reference rate in the monetary policy strategy of the SNB. It was chosen because it was the most widely used benchmark rate in Swiss franc markets. It still is today. However, central banks are capable of controlling the level of short-term interest rates in a variety of ways. Thus, the SNB can ensure that a discontinuation of the Libor would affect neither its monetary policy stance nor its ability to ensure price stability.