At the end of 2015, we reported on the challenges faced by M&A practitioners due to the odd interest rate environment, in particular when choosing the "right" interest rate in cross-border deals with a locked-box price mechanism (see M&A Perspective December 2015). In the meantime, the development of interest rates has exacerbated this issue: at the end of September 2018, the U.S. Federal Reserve (Fed) increased the target range for federal funds to a range of 2.0% to 2.25%. At the end of 2015, this range was at 0.25% to 0.5%. During the same period, the European Central Bank (ECB) decided to lower the interest rate on the deposit facility by 10 basis points to -0.40% (in March 2016). The Swiss National Bank (SNB) did not move its target range for 3-month CHF LIBOR by a single basis point: it remains at -1.25% to -0.25%. Now, what interest rate should be applied in an M&A transaction between a U.S. seller and a European based purchaser with respect to a Swiss target (e.g. interest on purchase price in case of a locked-box mechanism or default interest)?
For default interest, conceptually, a floating reference rate (with a floor at zero?) would seem appropriate. However, the top dog in this context, LIBOR, will be phased out by 2021, according to a statement made in July 2017 by Andrew Bailey, Chief Executive of the Financial Conduct Authority (FCA). How to fill the gap? M&A practitioners willing to adapt their contract templates struggle, as various benchmark rates mushroom around the globe. For the U.S., discussions circle around Secured Overnight Financing Rate (SOFR) and American Interbank Offering Rate (Ameribor). And since 2 April 2018, the NY Fed also produces and publishes the Broad General Collateral Rate (BGCR) and the Tri-Party General Collateral Rate (TGCR). In the UK, the Bank of England has set up a working group on sterling risk-free reference rates to find an alternative to LIBOR, which now recommends Sterling Overnight Interbank Average Rate (SONIA). For the Euro-Zone, the working group on Euro risk-free rates, set up by the ECB, aims to develop a new unsecured overnight interest rate before 2020. For Switzerland, the national working group for reference interest rates, co-chaired by a representative of the private sector and a representative of the SNB, presented the Swiss Average Rate Overnight (SARON®) as the best alternative to the Swiss Franc LIBOR. SARON is an overnight reference rate based on data from the Swiss franc repo market and calculated by SIX Swiss Exchange already since August 2009, including various average rates based thereon (e.g. SAR6M, representing the 6 months average). As per end of September 2018, SARON stood at around -0.75%.
Now, how to see the woods for the trees? Time will have to tell. In the meantime, contract drafters will have to remain on the lookout to identify the standards that the markets ennoble to the status of benchmark. Until then, the bouquet of reference rates presents both: a risk and an opportunity. But one thing remains certain for Switzerland: Given its deterring effect, parties have a strong incentive to actively contract out of the Swiss statutory fallback solution of 5% per annum.