Fritz Zurbrügg: Review of financial market developments, and various
interest rate and foreign exchange benchmark reforms
Introductory remarks by Mr Fritz Zurbrügg, Member of the Governing Board of the Swiss
National Bank, at the Media News Conference of the Swiss National Bank, Berne,
1 December 2014.
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In my remarks, I will begin by talking about developments on financial markets since the
middle of the year. Then I will speak about the various reform efforts in the area of interest
rate and foreign exchange benchmarks.
Developments on the financial markets
After a lengthy period of calm, volatility has increased slightly on the financial markets since
the middle of the year. In addition, investors' appetite for risk has dipped at times, and the
risk markets have suffered temporary setbacks. Thus we have observed two waves of selling
on the stock markets over the past few months (cf. chart 1). At the end of July, the European
stock markets, in particular, were affected, while those in the US and the emerging
economies proved more resilient. The second, more serious wave of selling set in at the end
of September, making a significant impact on the major non-European markets as well. The
main trigger for both waves was unexpectedly weak economic data in the core economies of
the euro area and Japan. To some extent, this negative effect was aggravated by geopolitical
tensions.
However, chart 1 also shows that these waves of selling were relatively short-lived. A
number of share indices, including the S&P 500 in the US and the SPI in Switzerland, rapidly
made good their losses and have in fact attained new highs in the meantime. Important
share indices within the euro area, such as the Euro Stoxx 50, have also been able to recoup
their losses, and their most recent levels roughly matched those of mid-year. Apart from the
continued recovery of the economy in the US and the predominantly sound corporate profits
on both sides of the Atlantic, the fact that central banks in the euro area, Japan and China
have eased their monetary policies is likely to have played an important role in this regard.
Looking at interest rates, yields on government bonds have continued to decline. This is
partly a reflection of low inflation and the decline in inflation expectations in the major
advanced economies. The fall in yields has been particularly marked in the euro area, where
investors are expecting further monetary policy easing measures. Accordingly, yields on
tenyear German government bonds have come down by more than 50 basis points since the
end of June, while the yields on comparable US government bonds have declined by some
30 basis points. In the same period, yields on ten-year Swiss Confederation bonds have
decreased by around 35 basis points, most recently hitting a historical low of about 0.3%.
Foreign exchange markets have been significantly affected by the relative strength of
economic developments in the US and the correspondingly higher interest rate expectations.
Since the end of June, the trade-weighted US dollar has risen by nearly 10%. By contrast,
the trade-weighted euro has lost over 3.5%, while the yen has lost almost 12% of its value.
Chart 2 shows that, since the middle of the year, the strength of the US dollar has also made
itself felt with respect to the Swiss franc. However, the chart also shows that the Swiss franc
has become stronger against the euro over the past few months. It is likely that this is mainly
due to two factors. On the one hand, the disappointing path of the euro area economy, and
the further easing in monetary policy associated with this, have been responsible for a
weakening in the euro. On the other, the pressure on the Swiss franc has reflected the strong
demand for safe investments, particularly in periods of increased geopolitical tension. Since
mid-year, the trade-weighted Swiss franc exchange rate has barely changed overall. Thus,
the Swiss franc is still high.
Reform efforts in the area of interest rate and foreign exchange benchmarks
This brings me to the progress that has been made in reforming interest rate and foreign
exchange benchmarks. In recent years, revelations of manipulations have undermined the
credibility of these benchmarks. At international level, the Financial Stability Board (FSB) is
coordinating the reform efforts. At the same time, country-specific reforms are being
implemented at national level. In Switzerland, responsibility for benchmarks lies, in principle,
with the private sector and these benchmarks are not regulated. Nevertheless, the SNB is
particularly interested that benchmarks for interest rates and exchange rates should be
credible, since they are important for well-functioning financial markets and for the
implementation of monetary policy. That is why the SNB has supported reform efforts in the
area of benchmarks by taking part in various national and international working groups. I
have reported here on these efforts on several occasions. The FSB has published two final
reports since our last media news conference, so this provides me with a good opportunity to
draw some initial conclusions.
Benchmarks for interest rates
As regards benchmark interest rates, the final report recommends pursuing two main
approaches in the future. First, existing interest rate benchmarks should be further improved.
Second, efforts should be made to develop alternative benchmark interest rates. Thus the
two-pronged approach for the future envisages, alongside improved Libor interest rates
which would still be based on unsecured money market transactions, the emergence of more
benchmark interest rates related to repo transactions or other near risk-free transactions.
The FSB's final report states that significant progress has already been achieved with the
Libor rates. However, not all of the requirements set by the securities regulators (IOSCO
standards)1 have so far been met. In particular, it still remains unclear whether the markets
upon which the interest rates are based are sufficiently liquid. A certain level of liquidity is
needed to ensure robust benchmark rates, i.e. rates based on a sufficiently large number of
transactions. The Libor administrator, ICE Benchmark Administration (IBA), reacted to the
FSB report by announcing further improvements to ensure that the Libor rates would become
better established through the use of actual transactions. Such actual transactions will be
used either directly, for calculating the Libor rates, or indirectly, for underpinning the
contributions. In this context, the inclusion of short-term loans to large customers or money
market instruments, in addition to interbank market transactions, is being examined as a
future possibility.
In order to assess the FSB proposals, surveys are being conducted to collect data in the
currency areas concerned. The SNB conducted such a survey at the beginning of summer
for Switzerland, collecting data on bank transactions on the interbank market and with large
customers, as well as on trade in money market instruments. More than 50 domestic and
foreign banks took part in the survey. The results confirmed that the small number of actual
transactions on the money market currently constitutes a problem for the creation of robust
benchmark interest rates. Consequently, it seems improbable that a pure transactions-based
approach could be implemented for the Swiss franc. This is also the case if other transaction
types and additional instruments are taken into account. For this reason, the Swiss franc
Libor will continue to be based mainly on contributions by participating banks.
As I mentioned before, in addition to improvements in the existing Libor interest rates, the
FSB also proposes that alternative benchmark interest rates be developed. In Switzerland,
alternative interest rates for very short-term Swiss franc transactions already exist. An
example of these on the secured money market is SARON,2 which is the basis for the
interest rate curve on the Swiss franc repo market. On the unsecured market we have the
TOIS3 fixing, which is related to transactions in the area of call money and is used for interest
rate derivatives. However, reforms were also necessary for the TOIS fixing. Consequently,
new standards have been in place since 1 October. These are in line with international
requirements and have resulted in a number of enhancements, including improvements to
supervisory structures and codes of conduct. For these benchmark rates, too, the underlying
transaction volume is currently very low.
Foreign exchange benchmarks
I will now turn my attention to benchmarks on the foreign exchange market. On the
international financial markets, currencies are traded around the clock. There are no final
rates for any given day. Given this situation, benchmarks on the foreign exchange market
provide numerous investors, such as investment funds or asset managers, with a basis
which they can use for uniform valuation of their portfolios. One of the best-known
benchmarks is the WM/Reuters fix, which is set daily at 4.00 pm, London time; it is calculated
as the median of actual foreign exchange transactions conducted within the period of one
minute.
The FSB working group took on the task of investigating the way in which these benchmarks
were fixed and recommending ways to improve them. The group's work was independent of
simultaneous investigations into foreign market manipulation by supervisory authorities in a
number of different countries, which resulted in the imposition of fines in November.
The final report presented at the end of September found that - unlike the situation for
benchmark interest rates - liquidity in the foreign exchange market was high and therefore
provided an adequate breadth of data for calculating benchmarks. However, the problem for
benchmark fixing in this area stems from a different source, namely the fact that trading
orders become heavily concentrated shortly ahead of the fixing time. This gives traders
opportunities to manipulate the price of the fixing to their own advantage. In order to
eliminate these opportunities, the working group is proposing that the fixing window be
widened, thereby broadening the range of data sources. In addition, the group also
recommends various codes of conduct guidelines for fixing orders. What is particularly
important is to ensure that banks do not share information with each other about customer
orders before the fixing. The SNB supports the recommendations contained in the report by
the working group. It is now up to the private sector, first and foremost, to implement these
recommendations.
The reforms carried out so far, with regard to both interest rate benchmarks and foreign
exchange benchmarks, are steps in the right direction. The SNB will carefully monitor
implementation of the reform proposals for foreign exchange benchmarks and provide
support, if necessary. In the case of interest rate benchmarks, the FSB's work will continue
with the further participation of the SNB.