The One-Way Interest Rate Swap – What Happens If Interest Rates Are Negative

Author:Dr. Ansgar Schott and Markus Winkler

Swiss National Bank introduced negative interest rates In December 2014, the Swiss National Bank ("SNB") announced the introduction of negative interest rates on sight deposits by financial institutions with the SNB. The main intention was to diminish the pressure on the then pegged rate of EUR/CHF 1.20. In January 2015, the SNB gave up on the peg with the immediate consequence of a substantial soar in the Swiss Franc. In order to prevent further unfavourable outcomes (especially for export oriented enterprises) the SNB tightened its negative interest rates by lowering its three-month London Interbank Offered Rates ("3-month CHF Libor") to -0.75 % and moved the target range for the 3-month CHF Libor down to -1.25 % and -0.25 %.

We explain below how negative interest rates can affect hedging transactions, in particular, interest rate swaps that are linked to the 3-month CHF Libor.

Does a negative interest rate constitute "interest"?

Switzerland has seen negative interest rates before. When in the 1960's and 1970's, the SNB imposed negative interest rates, the measure was restricted to funds from abroad. Back then, the Swiss Supreme Court decided that negative interests were commissions. It is unclear, however, whether that view would still be upheld today and in the current context.


Let's assume that a Swiss company borrows Swiss francs at a floating rate of interest based on the 3-month CHF Libor. In order to protect itself from potentially increased financing costs under such floating rate borrowing, the company enters into an interest rate swap with a swap dealer. The swap contract provides that on the one side, the swap dealer pays a floating rate of 3-month CHF Libor plus a spread of 0.5 % to the Swiss company, and on the other side the Swiss company pays a fixed rate of 2 % to the swap dealer. The bottom-line of the arrangement is that the Swiss company ends up with fixed rate financing costs of 1.5 % = 2 %-0.5 %.

Since the 3-month CHF Libor has been set to...

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