19 Nov 2018

Eurex | Eurex Clearing

SARON Futures: Transitioning the Swiss-denominated market smoothly to the new risk-free rate

Following the introduction of the Three-Month SARON® Futures to help the Swiss market transition to a new risk-free rate, Eurex spoke with Martin Bardenhewer, Head of Financial Institutions & Multinationals, Zürcher Kantonalbank and Co-chair of the Swiss National Working Group on Reference Rates (NWG), Pascal Anderegg, Interest Rate Derivatives Trader, Zürcher Kantonalbank, and Michel Erni, Head of Market Rates & Director at Basler Kantonalbank.

How can the SARON Futures help the market transition to the new risk-free rate?

Martin Bardenhewer, Head of Financial Institutions & Multinationals, Zürcher Kantonalbank and Co-chair of the Swiss National Working Group on Reference Rates (NWG):

Futures have been the most important instruments for the short end of the LIBOR-Swap curve. We expect the dominance of futures for short tenors to continue, and therefore, SARON futures are set to be a key instrument for liquidly trading in each segment of the SARON curve.

Michel Erni, Head of Market Rates & Director at Basler Kantonalbank: The input from the market side for a smooth transition becomes much more profound with the launch of SARON futures, bearing in mind that the SARON IRS market was established not very long ago, in April 2017. The introduction of new SARON futures completes the base for a new benchmark curve for the risk-free rate.

What are the key challenges for SARON and the SARON Futures?

Martin Bardenhewer: CHF is a small currency compared to most other IBOR currencies. Allocating liquidity to a small number of derivative contracts on SARON is key to a smooth transition away from LIBOR. Only if hedge instruments are liquid, or at least are recognized as due to become liquid in the near future, can interest rate risk in cash products like loans be managed without additional costs. Incentives to keep a LIBOR book will weaken quickly as soon as liquidity shifts from LIBOR derivatives to SARON derivatives: that is why the new SARON futures fill a gap.

Michel Erni: The market and all associated products have to adapt to a completely new methodology, which means changing from a forward-looking LIBOR to a backward-looking SARON. Some areas affected are, for example, the mortgage business, treasury, and possibly resulting in an increase in derivatives, to reduce this uncertainty to plan interest rate costs in advance.

How important is transparency post-LIBOR and how does SARON respond to the changing regulatory environment?

Martin Bardenhewer: SARON is calculated from transactions and binding quotes on CHF GC repos, by far the most important CHF money market segment. There are hardly any unsecured trades in the CHF money market, since rising capital requirements have made this segment inefficient.

Michel Erni: Because of the financial crisis and LIBOR scandals, regulators focus strongly on transparency, and this is the reason why SARON is based on Repo transactions, in contrast to LIBOR. This transparency - and hence, security - does come with a price: if we look for example at well-known LIBOR-based mortgages, clients do know their interest rate costs for the upcoming period after fixing of LIBOR in advance of this period. With SARON, however, overnight rates have to be compounded and thus clients come to know their final interest rate costs only after the period.

How smooth was the transition readiness to the new risk-free rate?

Pascal Anderegg, Interest Rate Derivatives Trader, Zürcher Kantonalbank: For the time being, SARON swaps, introduced in 2017, have fully replaced CHF Tomorrow-Overnight-Index Swaps. So far, they have not gained significant market share from LIBOR swaps. Without the imminent necessity to switch to SARON, most of the liquidity in the OTC IRS market remains in LIBOR. We assume that many institutions are still in the process of adjusting IT-systems and risk models to be able to handle SARON-based derivatives. By continuing to promote more SARON-based derivatives, the NWG is supporting the CHF market in the enhancing of transition readiness away from LIBOR. In this respect, SARON futures play an important role, as they allow market participants to move away from LIBOR-based futures for the hedging of short-term interest rate risks. Moreover, the futures, if sufficiently liquid, will be used to strip the short end of the swap curve, making the SARON swap market more liquid and robust.

How does SARON Futures help to efficiently trade CH-denominated ETD & OTC products?

Pascal Anderegg: Having SARON futures visibly on Central Limit Order Books (CLOBs) will facilitate the pricing of short-term forward starting swaps, which can be used for the hedging of changes in monetary policy rates.

Michel Erni: As there are still big interest rate hedging needs in the market for short- and long-term interest rates, a liquid alternative for CHF-3m-Futures is key for all participants. We now see more and more businesses based on SARON, and both the SARON Futures and SARON IRS help to eliminate basis risk. We expect more transfers from LIBOR-based hedging to SARON in the near future. Being prepared early is very important in our view.

How important are the new SARON futures to have robust fixed income markets?

Pascal Anderegg: Currently, the fixed income market is marked against LIBOR swaps. As the CHF LIBOR swap market will most likely cease to exist by the end of 2021, it is important to have a robust SARON swap market in place. Having SARON futures visibly on screens will help build confidence in the SARON swap market. However, it cannot be stressed enough how important it is for market participants to make the necessary adjustments to their systems and models and start relying on the SARON swap market. The launch of the SARON futures should be the starting signal to switch from LIBOR to SARON.

Michel Erni: In a benchmark curve for robust money and fixed income markets, futures contracts have to be considered as part of the pricing, and improve credibility overall.   

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