Fritz Zurbrügg: Financial markets, the management of Swiss currency
reserves and interest rate 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,
12 December 2013.
* * *
I will begin today by looking at the situation on the financial markets. Then I will talk briefly
about developments in our foreign exchange holdings. I will close with a few comments on
the progress that has been made in reforming interest rate benchmarks at both international
and national level.
Situation on financial markets
Since our last media news conference in June, the positive risk sentiment on financial
markets has been largely maintained, as is evident from the soaring share prices, among
other things. In the past few weeks, the key US indices Dow Jones and S&P 500 have
reached new record levels, thereby exceeding the peaks attained prior to the global financial
crisis. In addition, Japan's Nikkei Index and the most important western European stock
exchange indices, including the Swiss SMI, have again recorded significant gains in recent
months.
Despite all the euphoria on the stock exchanges, we must not forget that it is not only the
improvement in the economic outlook but also the continuation of the very expansionary
monetary policy around the world which is behind this positive risk sentiment. In May and
June we saw what could happen if expectations of a less expansionary monetary policy
course become widespread in the market. At that time, the announcement by the US Federal
Reserve of a possible reduction in its bond purchase programme caused share markets to
plunge temporarily. The wave of selling did not recede until the beginning of July, when the
Federal Reserve, the European Central Bank and the Bank of England reassured markets
that key rates would remain at very low levels until the recovery of the individual economies
was on a firm foundation.
On bond markets, interest rates continued rising in June and July. Since then, they have
largely moved sideways. This applies to US, UK, German and Swiss government bonds, in
particular. Until the beginning of September, yields on ten-year Confederation bonds rose to
almost 1.2%. They are currently at around 1%, which means that they have increased by
about half a percent year-on-year. Government bonds in the emerging economies were
particularly strongly affected by the rise in interest rates, since the expectation of an
impending monetary policy normalisation in the US led to significant capital outflows from
these countries.
By contrast, risk premia on government bonds for the peripheral euro area economies did not
increase very much. Moreover, these risk premia have fallen again in the meantime so that
returns on government bonds in the peripheral economies are now in fact lower than at the
beginning of the year. This is probably due, not least, to progress in overcoming the crisis as
well as encouraging economic data from the euro area. However, investors are still cautious,
so that demand is still high for investments seen as safe havens. Consequently, in recent
months, the Swiss franc has moved in a narrow range above the minimum exchange rate of
CHF 1.20. Nevertheless, in view of the progress in the euro area, many market participants
expect that the Swiss franc will depreciate.
Despite this progress, it is still too early for an all-clear. Conditions on financial markets could
change again rapidly. In order to counteract possible tensions on financial markets and
lessen their potential impact on the economy, six leading central banks including the Swiss
National Bank (SNB) converted their reciprocal swap lines into a standing arrangement in
October. These swap lines had initially been arranged on a temporary basis at the height of
the financial crisis, in order to secure access to liquidity.
Developments in foreign exchange reserves
At the end of September 2013, our holdings of foreign exchange reserves stood at
CHF 443 billion. I would now like to make a few comments on income from foreign exchange
reserves. I should begin by stressing that monetary policy has priority over investment policy,
and that generating income is not the primary objective of investment policy. We are guided,
first of all, by the criteria of security and liquidity. The criterion of security covers primarily the
reduction of risks such as market, credit and concentration risks. In addition, it is important
for us to maintain the real value of the foreign exchange reserves in the long term.
Consequently, the long-term return on investment must match the average rate of inflation. If
the criteria of security and liquidity are fulfilled, our investment policy aims to achieve an
additional return over and above the real maintenance of value.
The return on foreign exchange reserves is made up of current income plus changes in the
value of the investments. The income takes the form of interest and dividend payments on
the bonds and shareholdings. In view of the current low interest rate environment, these
amount to only around 2% of foreign exchange reserves per year. Just like investments that
fall due, income is generally reinvested. Therefore, foreign exchange reserves tend to rise
even when we do not need to purchase additional foreign exchange.
The other component of returns is changes in the value of foreign exchange reserves. We
value all investments at market prices and in Swiss francs. Consequently, changes in the
prices of interest-bearing paper and shares as well as exchange rate movements have a
direct impact on the net result for investment. If the Swiss franc strengthens against the
investment currencies, this results in a valuation loss on the foreign exchange reserves. The
chart shows the net investment result since the first quarter of 2010 for the foreign exchange
reserves, as well as for the individual components. The dominant role of exchange rate
movements is clearly evident. In the past, too, exchange rate movements have posed by far
the greatest risk to our portfolio. Taking a long-term view, exchange rates have been
responsible for about 80% of the total risk on the foreign currency reserves.
Reform of interest rate benchmarks
Following last year's revelations that Libor interest rates had been manipulated, various
activities to reform the Libor and other interest rate benchmarks are under way. The SNB is
involved in these reform activities at both international and national level. The objective is to
improve the credibility and acceptance of the existing interest rate benchmarks or, where
appropriate, to take steps to ensure the provision of robust alternative interest rate
benchmarks.
International efforts are being coordinated by the Financial Stability Board on behalf of the
G20 countries. They involve not only central banks and supervisory authorities but also an
international group of private sector financial market participants. They are examining, first,
the extent to which the existing Libor interest rates fulfil the requirements laid down by
securities supervisors last July (the IOSCO standards). Second, they are investigating
whether there are alternative interest rate benchmarks which would better meet the needs of
the market and the requirements of supervisory authorities in the longer term. Alternatives to
the Libor are being developed by the private sector group, which also includes Swiss
representatives. The Financial Stability Board plans to present the results of its work in the
middle of next year.
At the international level, activities are also under way to regulate the interest rate
benchmarks as well as other important reference variables on the financial markets. In
London, the Libor is already now subject to a supervisory regime. In Brussels, a bill has been
proposed which would regulate all interest rate benchmarks used in the EU. In Switzerland,
too, a need for regulatory action is likely to emerge in this area.
At the national level, the SNB and FINMA are talking to financial market participants about
ensuring a more robust construction of the interest rate benchmarks which are fixed in
Switzerland. The aim is to widen the data pool and improve the calculation methods, and the
focus is on reference interest rates for very short-term Swiss franc transactions, specifically
one-day terms. These transactions form the basis for the Swiss franc yield curve. The two
benchmarks involved are, first, the TOIS fixing, which is used for interest rate derivatives in
the Swiss franc money market, and second, SARON, which serves as the basis for the yield
curve on the Swiss franc repo market. Progress has already been achieved on both interest
rate benchmarks. Although the level of activity on the money market remains persistently
low, they continue to be available to the market as a basis for interest rate transactions in
Swiss francs. However, the Libor retains its position as the most important interest rate
benchmark in the money and capital markets.