LIBOR and SARON: What Is the Difference?

LIBOR and SARON: What Is the Difference?

Christian Bahr 06 Jan 2022 4 minutes

The controversial LIBOR standard for reference interest rates has no longer been supported since 2022. SARON, which is calculated by SIX, has provided an alternative for the Swiss franc market since as far back as 2009. What are the advantages of SARON over LIBOR? Read it in this blogpost.

Table of Contents

Why Are Reference Interest Rates Needed?

Reference interest rates are important for the economy. And not just as far as monetary policy is concerned. Financial contracts for loans, savings deposits and mortgages all refer to these rates, which also provide an essential baseline on the derivatives market or for structured products. LIBOR, the London Interbank Offered Rate, was until 2022 the standard – also in Switzerland.

Why Was LIBOR Replaced?

There was a time when LIBOR was an acronym with which few outside the world of finance were familiar. But the manipulation of the reference rate led to a public debate over LIBOR’s future that has dragged on for years. It has become quite clear that there is no future for LIBOR. LIBOR has no longer been supported since 2022.

The bottom line was that estimates provided by a small number of banks are no longer adequate. Over the past few years national working groups across the world implemented improvements or developed new benchmark interest rates, as is the case in Switzerland. What the new reference rates have in common is that they are overnight rates based on transactions as opposed to estimates.

When Was LIBOR Being Replaced?

Support for LIBOR has been removed in 2022 and banks had to switch contracts, products, systems and processes based on the rate to new, alternative reference rates (ARR). Since 2009, SIX has provided a robust alternative to the “CHF LIBOR” rate in the shape of SARON, the Swiss Average Rate Over Night.

What Was the Difference between SARON and LIBOR?

1. Money Market: Secured vs. Unsecured

To Which Money Market Does the SARON Refer?

SIX operates the fully automated trading platform (SIX Repo) for the secured money market (shortterm credit funding) in Switzerland. The SARON reference rate reflects this repo market. “Funding against collateral” is the rule here.

To Which Money Market Did the LIBOR Refer?

The LIBOR reference rate reflected the unsecured money market (short-term credit funding). “Funding against creditworthiness” is the rule here (no collateral required).

2. Base: Industry vs. Panel

What Is The SARON Based On?

More than 160 banks and insurance companies take part in the Swiss repo market, including the Swiss National Bank (SNB), which uses it to supply Switzerland’s economy with liquidity. Banks receive funds from the SNB by depositing securities as collateral. They pledge to buy back those securities at a later date and pay interest. Banks also borrow money from each other using this principle (secured interbank market).

What Was The LIBOR Based On?

A group of 11 to 16 panel banks was involved in setting LIBOR. The panel banks answered the question of what interest rate they could borrow funds at if they ask for an interbank offer in a reasonable market size. Illicit collusion between some of those panel banks caused the LIBOR scandal in 2011.

3. Calculation: Actual Interest Rates vs. Estimated Interest Rates

How Is the SARON Calculated?

Actual concluded transactions and quotes flow into the calculation of SARON. That’s approximately 110 interest rates per day on an annual average.

How Was the LIBOR Calculated?

The estimates submitted by the panel banks flowed into the calculation of LIBOR. Between 5 and 8 interest rates were used, depending on the number of banks involved. The 3 to 4 highest and lowest interest rates were discarded.

4. How Was the LIBOR Calculated?

When Is the SARON Published?

- Calculated/published every ten minutes
- Fixing conducted three times a day (closing rate: 6:00 pm)
- Available in one currency (CHF)

When Was the LIBOR Published

- Calculated once a day
- Published once a day
- Available in five currencies (CHF, EUR, GBP, JPY, USD)

Where Can SARON Be Found?

  1. Interest Rate Swaps
     A swap involves two parties agreeing to exchange their liabilities for a set period of time – for example, the payment of interest on a debt. A typical interest rate swap might include one party paying a fixed rate while the other party is paying a variable rate based on the SARON. These Overnight Index Swaps, as they are known, are key instruments used when hedging against short-term interest rate changes.
  2. Futures
    Futures are standardized trading instruments that obligate the buyer to buy an asset at a specified price on a fixed date, and the seller to sell this asset accordingly. Futures that use the SARON as the base rate allow market participants to hedge against future interest rate changes, or to speculate on them.
  3. Clearing Houses
     Clearing houses like SIX or LCH in London reduce counterparty risk in securities trading as central counterparties and increase market stability. The SARON is used as the reference interest rate in this process.
  4. Mortgages
    SARON mortgages offer variable interest rates that are adjusted regularly. This can be particularly advantageous for borrowers in periods of low interest rates.
  5. ETFs
    An Exchange Traded Fund (ETF) based on the SARON offers institutional and private investors an instrument for accessing the money market in Swiss francs. That improves liquidity and diversification.
  6. Bonds
    Floating rate bonds based on SARON are variable-interest bonds in which the interest rate is regularly adjusted according to the SARON. This is advantageous for investors when money market interest rates are rising.
  7. Capital Protection Products
     Capital protection products are structured financial products that offer investors either full or partial safeguarding of their initial investment amount upon maturity. For example, there is the option to combine a derivative on a share with a bond whose interest rate is based on the SARON.

 

Christian Bahr

In his role as Head Index Services at SIX, Christian Bahr is responsible for the entire index business and the related services. He also chairs the index commissions. He has broad-based expertise in passive investments and indices as well as many years of experience in the markets data business. He was responsible for product development, engineering and index management in his previous roles at STOXX (Deutsche Börse) and the Dow Jones Indexes.

The Reference Interest Rate for the Future

Do you want to dig deeper? What are the SARON Compound Rates? 

Calculate a compounded interest rate yourself here.

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