Swiss FINMA says risks related to transition away from LIBOR are decreasing
The Swiss Financial Market Supervisory Authority (FINMA) today published its 2020 Risk Monitor. The report provides an overview of what FINMA believes are the most important risks currently facing supervised institutions and describes the resulting focus of its supervisory activity.
In FINMA’s view, the principal risks for the supervised institutions and the Swiss financial centre include:
- the persistent low interest-rate environment (increasing);
- a possible correction on the real estate and mortgage market (increasing);
- a disorderly abolition of LIBOR benchmark interest rates (decreasing);
- cyberattacks (increasing);
- money laundering (same);
- increased impediments to cross-border market access (same).
The regulator notes that the date on which LIBOR is to be abolished is fast approaching. The use of LIBOR reference rates for financial instruments is still widespread. Progress has been made in efforts to ensure an orderly transition from LIBOR to alternative interest rates. The risk is decreasing overall in particular thanks to fallback clauses to alternative interest rates in the derivatives area.
A survey carried out in June 2020, however, showed that financial instruments totalling at least CHF 14 trillion and still pegged to LIBOR will only expire after 2021. Of these, over CHF 2 trillion worth are specifically pegged to LIBOR in Swiss francs.
The discontinuation of LIBOR from the end of 2021 could therefore have a significant impact on the market. Inadequate preparations for the replacement of LIBOR interest rates – including CHF LIBOR rates – thus continue to pose a significant risk.
FINMA notes that SARON (Swiss Average Rate Overnight) has been available in Switzerland since the summer of 2019 and is gaining significance as a money market rate. Therefore, an alternative to the CHF LIBOR already exists in Switzerland. In fact, the changeover of mortgages from LIBOR to SARON has already begun.
FINMA requires 26 banks – selected on risk-based grounds – to report on their progress in quarterly self-assessments. These assessments make it clear which obstacles currently stand in the way of a smooth winding-up of the existing LIBOR positions (for example, uncoordinated approaches in the various jurisdictions, and lack of operational readiness).
The self-assessments also indicate that, in the first half of 2020, LIBOR-based contract volumes did not fall significantly but actually rose again.
The increase in LIBOR-based volumes could be due to the corona pandemic, which has made it necessary to grant loans exceptionally quickly. However, the crisis is not a reason for delaying the changeover, FINMA warns.
The regulator says it will make further efforts to ensure that the financial institutions under its supervision are well prepared for the discontinuation of the LIBOR reference interest rates by initiating a dialogue with institutions that are especially affected and verifying that the risks entailed by the possible discontinuation of LIBOR are properly recorded, contained and monitored.
FINMA will place particular emphasis on the timely and robust migration of existing LIBOR contracts that extend beyond 2021 and expansion of the range of products based on alternative interest rates.
In the case of derivative contracts that cannot be migrated or adapted (the so-called tough-legacy contracts), a risk assessment must be available for each contract or contract type and specific measures taken to minimise risk, especially with regard to the legal and valuation risks.