Swiss Debt Markets

Abstract

The stable Swiss franc currency, low-interest rates, high market liquidity, and long-term funding opportunities have made Swiss debt markets an attractive source of capital for borrowers, such as businesses, governments, and supranational organizations. The exceptionally well-developed long-term debt market has reduced the need for short-term financing and has proven highly resilient during times of turmoil. Today, Switzerland has a non-public borrowers’ market that is larger than the public borrowers’ segment, partly due to the federal debt brake. A distinctive feature is the Pfandbrief market which has remained loss-free during its 90-year history. While the share of foreign bonds has decreased over time, Sustainable Bonds, comprising Green Bonds, Social Bonds, and bonds linked to sustainability have emerged as a new important bond type.

Introduction

Switzerland offers investors and capital-raising firms important structural benefits, such as efficient price discovery and a favorable regulatory environment. Its debt markets feature a variety of advantages to investors and borrowers.

Debt instruments denominated in Swiss francs are attractive to investors due to the portfolio diversification opportunities they offer to global portfolios seeking a safe and stable currency (and as an alternative to the euro). In addition, borrowers benefit from Switzerland’s relatively liquid markets, especially for long-term debt instruments, as well as the nation’s political stability, high domestic saving rate, substantial placing power, low inflation, open capital markets, lack of exchange controls, reasonably priced legal system, and reputation as a safe haven. Switzerland’s position as a leading international financial center is therefore well-founded.

The Swiss debt market has long been a safe retreat for domestic and international investors—especially during times of turmoil. Its impressive resilience during the 2007–2009 financial crisis is just one example of this market’s built-to-last quality. The same resilience was observed during the COVID-19 pandemic.¹ Even though the growth rate of Switzerland’s debt market has been slow compared to international competitors, it distinguishes itself by having a non-public borrowers’ market that is larger than the public borrowers’ segment and a vibrant foreign-issuer market.

Switzerland’s Unbalanced Debt Market

Despite its obvious strengths, the Swiss franc’s position in the international debt markets is not evenly balanced. In general, the Swiss franc has depth and breadth only in medium- to long-term maturities of the domestic, foreign, and Euromarket segments (see Table 8.1). Participation in the short-term market is relatively weak. Except for the Euromarkets and Swiss franc foreign debt markets, which have been exempt from the Swiss stamp duty since 1993, short-term Swiss franc debt instruments are not competitive internationally.

Table 8.1 Overview of the Swiss franc Debt Markets

At year-end 2021, short-term debt securities in Switzerland made up only 2.4 percent of the aggregate volume of outstanding debt securities.² With 7.2 percent, this share is slightly higher in Switzerland’s international debt securities segment. Yet, relative to other major international financial centers, it is still a tiny portion of its outstanding debt compared to a global average of 14.4 percent. Figure 8.1 shows the shares of domestic and international debt securities by country and the percentage of short-term debt securities in each country’s international debt securities markets. Hence, Switzerland’s short-term securities markets, both in the domestic and foreign segment, are relatively shallow.

Fig. 8.1

(Source Bank for International Settlements (BIS), Statistics Explorer, https://stats.bis.org/statx/srs/table/c1 [Accessed on August 20, 2022]. Full publications are available on the BIS website free of charge: https://www.bis.org)

Shares of domestic and Short-Term Debt securities, by country: December 2021

Switzerland’s Shallow Market for Short-Term Debt

Relative to other international centers, Switzerland’s short-term markets are undeveloped. An optimistic explanation is the nation has an exceptionally well-developed, long-term debt market that has reduced the need for short-term financing. Other explanations are the nation’s low level of government debt (federal, cantonal, and municipal) relative to many other developed nations, the nation’s tax disincentives, the Swiss National Bank’s (SNB’s) relative absence from this market, modest short-term borrowing by the country’s two major banks, moderate demand by Swiss corporations, and the long-term oriented financing by the private sector. Also, currency risks might impact foreign borrowers of Swiss francs.

Low Level of Government Debt

The diminutive size and lopsided maturity composition of Switzerland’s state debt are among the reasons for the nation’s relatively anemic money market development. Its federalist direct-democracy government structure has kept national deficits lower than in nations with more centralist systems. This structural advantage was enhanced in 2003 when the Swiss government instituted its so-called debt brake to ensure the Confederation’s liabilities remain balanced over business cycles, with boom-time surpluses offsetting recessionary deficits.³

Switzerland’s debt brake was designed to promote a structurally balanced budget at the Confederation (i.e., federal) level. In concept and practice, it works in unison with a constitutionally mandated upper limit on significant tax rates by controlling government expenditures during a business cycle. The idea behind the debt brake is to maintain fiscal automatic stabilizers, which cushion the country’s economy from short-term shocks and focus on balancing the budget from peak-to-peak or trough-to-trough over the more extended business cycle period.

Figure 8.2 illustrates a symmetric business cycle intertwined around mildly expanding government expenditures. During the expansionary stage of the cycle, budget surpluses rise stimulated by passive increases in government tax revenues. Switzerland’s debt brake restricts the use of these surplus funds so they can finance passive deficits (that are sure to occur) during recessionary periods. Of course, no nation can count on its business cycles being as uniform as the one depicted. As a result, there are no guarantees that a debt brake rule will create a balanced budget at the end of the business cycle. Nevertheless, this conservative fiscal policy has enormous support in Switzerland and has successfully curbed the nation’s deficits and the government’s role in the economy.

Fig. 8.2

(Source Authors’ representation based on Swiss Federal Department of Finance, The Debt Brake, https://www.efd.admin.ch/efd/en/home/fiscal-policy/the-debt-brake.html [Accessed on July 10, 2022])

Passive surpluses and deficits around a Short-Term Business Cycle

Switzerland’s debt brake combines the benefits of a balanced budget rule and an expenditure rule to contain the government’s demand for credit. It also restrains government creep—the tendency for government expenditures to grow as a percent of GDP, with time. Switzerland’s debt brake keeps the government’s basic expenditures independent of cyclical variations. To protect the nation’s social welfare network from political or economic interference, expenditures that fund unemployment compensation and other social welfare programs (i.e., critical expenditure-side automatic stabilizers) are managed in separate accounts. They are not subject to the debt brake.

Under normal conditions, budgeted expenditures must be linked to expected revenues, and they may be increased only if they are financed by additional anticipated receipts or offsetting spending cuts (similarly, tax cuts require offsetting spending cuts). An exemption clause is included in the rule to ensure the debt brake remains sufficiently flexible to handle extenuating circumstances (e.g., natural disasters and severe recessions). This clause allows the Confederation to make extraordinary expenditures that deviate from the rule. To prevent over-reliance on this exception, a legislative provision (the so-called extension) was instituted in 2010, which requires excessive expenditures to be funded in the future years.

The COVID-19 pandemic, for example, triggered such additional expenditures. The resulting extraordinary annual deficits from 2020, 2021, and 2022 were booked to the amortization account each year.⁴ By the end of 2022, the amortization account was expected to show a deficit of CHF 25–30 billion. So far, the supplementary profit distribution by the SNB was used to reduce the amortization account. In March 2022, the Federal Council dispatched a temporary amendment of the Financial Budget Act to allow the usage of the SNB’s budget surpluses for reducing the amortization account’s deficit. It has to be kept in mind, though, that these distributions are contingent on SNB’s ability to generate profits in the future.

In economic terms, a secularly rising GDP combined with a cyclically based debt brake is a good recipe for medium-term reductions in the nation’s debt-to-GDP ratio. In Switzerland, this result may be impeded somewhat because the debt-brake rule applies only to the Confederation and not the cantons or municipalities. In smaller entities, budgets are more directly controlled by citizens. In fact, the Confederation’s debt slightly decreased in absolute terms between 2010 and 2020, but cantonal and municipal debt levels grew during the same period (Fig. 8.3).

Fig. 8.3

(Source Authors’ calculations based on data available from the Federal Statistical Office, Expenditure and debt, https://www.bfs.admin.ch/bfs/en/home/statistics/general-government-finance/expenditure-debt.html, Swiss public finances 2019–2022, https://www.bfs.admin.ch/bfs/en/home/statistics/general-government-finance/expenditure-debt.html, Switzerland’s financial statistics for 2017, https://www.bfs.admin.ch/bfs/en/home/statistics/catalogues-databases/publications.assetdetail.10287487.html, Switzerland’s financial statistics for 2013, https://www.bfs.admin.ch/bfs/en/home/statistics/catalogues-databases/publications.assetdetail.350884.html [Accessed on July 12, 2022])

Development of government Debt 2010–2020 (CHF billions)

However, as Fig. 8.4 shows, overall public debt levels as a percentage of GDP decreased substantially between 2005 and 2019. Although the debt break was passed in 2003, it was not fully operational until 2007. But the strict implementation has yielded a sharp reduction in both the absolute level of government debt and its size relative to GDP. In 2020, the COVID-19 induced expenditures led to an increase in federal and cantonal debt, which can be seen in Figs. 8.3 and 8.4.

Fig. 8.4

(Source Authors’ representation and calculations based on data obtained from: Swiss Federal Department of Finance, https://www.efv.admin.ch/efv/de/home/themen/finanzstatistik/daten.html#118810996 [Accessed on July 12, 2022]; Federal Statistical Office, Bruttoinlandprodukt, lange Serie, https://www.bfs.admin.ch/bfs/en/home/statistics/national-economy/national-accounts/gross-domestic-product.assetdetail.18584979.html; Expenditure and debt, https://www.bfs.admin.ch/bfs/en/home/statistics/general-government-finance/expenditure-debt.html; Switzerland’s financial statistics for 2017, https://www.bfs.admin.ch/bfs/en/home/statistics/catalogues-databases/publications.assetdetail.10287487.html; Switzerland’s financial statistics for 2013, https://www.bfs.admin.ch/bfs/en/home/statistics/catalogues-databases/publications.assetdetail.350884.html [Accessed on July 12, 2022])

Public Debt as % of GDP 1993–2020 and its moving 5-year average (dotted line)

As the COVID-19 pandemic and other exceptional circumstances illustrate, Switzerland’s debt brake is still ambitious, and its powers, in the long run, will be tested over time. One reason for skepticism is that Switzerland faces the same demographic profile as many other countries with aging baby boomers, who will need increasing care as time progresses. These increased demands will likely strain Switzerland’s public finances and seriously challenge the debt brake. Some cantons led the way by implementing their debt brakes before the Swiss federal government’s decisive move. Since the debt brake’s introduction at the national level, other cantons have also followed this fiscally conservative path.⁵

Swiss tax revenues are distributed approximately equally among the federal, cantonal, and municipal governments. Yet, the federal government has been responsible for the lion’s share of borrowing. Between 2010 and 2020, federal (including social security), cantonal, and municipal shares of total government borrowing averaged 53 percent, 25 percent, and 22 percent, respectively (see Table 8.2). However, the percentage of federal borrowing (including social security) has come down in this period from 58 percent (2010) to 48 percent (2020), while the share of cantonal borrowing rose from 21 percent (2010) to 28 percent (2020).

Table 8.2 Swiss Government Borrowing Activity by Level of Government: 2013 to 2021

Tax Disincentives: Federal Stamp Duty

Switzerland’s Federal Stamp Duty and the laws that regulate them have long been cited as key reasons for the pallid development of Switzerland’s money markets. By raising the tax burden above competitive international levels, they have been blamed for sizeable losses of Switzerland’s mutual fund business to Luxembourg and the loss of substantial equity and Eurobond businesses to London during the 1980s after the law was introduced.

The rules governing Switzerland’s federal stamp taxes are based on the 1973 Stamp Duties Act. For years, this Act imposed duties a) on primary issues, b) secondary market trades, and c) some insurance premiums. Until 1993, a flat tax was imposed on all (long- and short-term) security issues and transfers in Switzerland. For long-term Swiss franc instruments, the tax burden had only a minor impact because it could be amortized over many years of the instrument’s lifecycle. By contrast, short-term instruments bore the entire tax burden, pricing the Swiss franc instruments out of the broader international markets. Furthermore, the stamp duty encouraged investors to hold their instruments to maturity rather than bear repeated trading-tax charges. As a result, actual and potential liquidity in the secondary markets was relatively weak.

Reform came in September 1992, when the Swiss electorate voted to abolish the stamp duty on money market transactions (e.g., mutual funds certificates, investment certificates, and dealer trading positions).⁶ In its place, a stamp tax was implemented that varied with a security’s maturity . Reaction to these reforms was very positive, as liquidity in Swiss equity markets increased quickly and sizably, whereas issues in the short-term debt market remained relatively costly.

Chapter 12, Swiss Taxes on Investment and Financing, discusses the specifics of Switzerland’s stamp tax in greater detail. For now, it is crucial to understand that Swiss politicians have begun to react encouragingly to persistent calls for reform. In December 2011, the Swiss Federal Council abolished (effective March 1, 2012) stamp duties on the issuance of long-term and medium-term bonds, money market instruments, and shares issued in connection with convertible bonds (i.e., so-called coco bonds). However, in the public referendum on February 13, 2022, the Swiss population rejected the abolishment of the stamp tax on equity issues. Therefore, the necessity for further reforms persists, with many hoping that Switzerland might, one day, abolish all stamp duties.

SNB’s Relative Absence from the Short-Term Market

Another possible explanation for Switzerland’s relatively shallow market for short-term certificates is the SNB’s relative absence from the market as a regular buyer or seller of federal debt instruments, partly due to its legislative framework. In particular, the SNB cannot purchase newly issued debt securities from the Confederation, the cantons, and the municipalities. However, the SNB can acquire such instruments on the secondary market. Although the SNB has tried to take a more active role in the domestic debt markets since 1979, government debt has been a distant second compared to the broad and deep foreign exchange markets, where changes in the nation’s monetary base can be accomplished with less impact on the financial markets. At the year-end of 2021, the SNB held a position of CHF 906 million in Confederation bonds, equaling about 1.5 percent of outstanding Confederation bonds and less than 0.1 percent of SNB’s foreign currency investments.⁷

Modest Short-Term Borrowing by the Major Banks and Swiss Corporations

The structure of the domestic banking system is another reason for Switzerland’s relatively undeveloped money market. Though an active interbank market exists, it is small relative to other nations, largely reflecting the dominance of Switzerland’s two major banks and their penchant for financing a large portion of their needs via the interbranch (rather than interbank) market. Similarly, Raiffeisen banks and regional banks have organized their own internal funding systems and rely less heavily on external markets for liquidity.

Moderate Demand by Swiss Corporations

Swiss corporate demand for short-term credit (and, therefore, the supply of tradable, short-term credit instruments) is also tiny compared to many competitor nations due to the tendency of Swiss companies to finance their needs with internal cash flows. When short-term funds are desired, they are usually secured through bank loans and lines of credit rather than the issuance of tradable commercial paper. If debt financing is needed or considered beneficial (e.g., for tax reasons), Swiss corporations, on average, prefer long-term debt to short-term debt. It gives higher planning certainty, even though in times of a normal term structure of interest rates, financing with long-term debt involves a higher cost of capital.

Currency Risk

Also, currency risk has restricted foreign demand growth for short-term Swiss franc debt. Significant risks are associated with unhedged positions in a currency that can appreciate as strongly as the Swiss franc. Even though changes in the spot and forward Swiss franc exchange rates should adjust to offset international interest rate differentials, this cause-and-effect relationship is far from perfect. As a result, borrowers, lenders, and traders often need to moderate exchange-rate risk. To be sure, financial tools are available to hedge these risks, but the added cost reduces demand for Swiss franc money market financing.

Distinguishing Features of Switzerland’s Debt Market

Every capital market has its particular characteristics, and Switzerland is no different. One way to characterize Swiss debt markets is by the prominent features of its borrowers. High-quality companies with well-known names and impressive industrial and geographic diversity tap the Swiss debt markets. Switzerland’s debt markets also rely on particular accounting standards.

Quality of Swiss Franc Borrowers

Despite the wide range of national and international borrowers (e.g., corporations, governments, central banks, and supranational organizations) that tap the Swiss capital markets each year, the nation has developed a reputation for catering to borrowers with relatively high international credit ratings. While this may be true, ratings alone are insufficient to explain Swiss financing terms and conditions, and borrowing frequency and name recognition are also important.

During the early 1990s, Switzerland was home to a thriving market for privately placed, equity-linked notes of low-capitalized, and high-growth foreign companies (mainly from Asia). Several significant factors contributed to the reversal of this trend, primary among which were the liberalization of Swiss capital exports,⁸ increased importance of liquidity due to Swiss Exchange innovations ,⁹ easing of the Swiss (transfer ) stamp duty,¹⁰ and the Asian Financial Crisis of 1997 .¹¹ All of these developments ultimately made financing conditions less attractive for foreign companies, due to more capital being invested abroad and in different products or shifts in exchange rates like in 1997. We will return to these developments later in this chapter.

Name Recognition and Rarity Value

Name recognition and rarity value are essential factors in the Swiss franc debt markets. Unsurprisingly, top-rated foreign companies and countries have been active borrowers on favorable terms in the Swiss market. Yet, lower-rated borrowers have also achieved very competitive borrowing terms—especially when Swiss investors are familiar with their names. Corporations like General Electric (through its finance subsidiary GE Capital) and sovereigns, such as Austria, Germany, Italy, and Belgium, are just a few well-recognized borrowers that tap the Swiss franc debt markets on a fairly regular basis.¹² It is true that the anticipation of more frequent borrowing appearances or the perception of irresponsible fiscal management can make Swiss franc financing more expensive. At the same time, stable and well-respected companies from all corners of the world have found Switzerland to be an active market that offers consistently attractive rates.

Exposure to the Swiss markets is a clear benefit, but over-saturation can lead to wider interest spreads. Casual empiricism bears witness to this relationship by comparing the yield-to-maturity (YTM) of debt issued by two seemingly identical companies (i.e., concerning country, industry, and credit risks) with ostensibly equal debt terms (i.e., similar issue dates, nominal value, and durations). Compagnie de Financement Foncier (CFF) and Valiant Bank’s Covered Bond issue allow for an interesting comparison because they are in similar businesses and share the same credit rating. Yet, CFF paid a slightly lower rate for debt with a shorter time to maturity than Valiant Bank (see Table 8.3). In part, the difference might be explained by the size of the company and the borrowing track record. With 18 debt issues between 2017 and 2022, CFF was borrowing an aggregate volume of EUR 21.1 billion. By contrast, Valiant Bank had nine Covered Bond issues for only CHF 2.6 billion in total during the same period.

Table 8.3 Comparison of Borrowing Rates on SIX Exchange (Compagnie de Financement Foncier versus Valiant) as of October 28, 2022

Industrial and Geographic Diversity of Borrowers

Table 8.4 shows the top 15 foreign corporate public debt issuers in Switzerland ranked by the aggregate amount borrowed in Swiss franc between 2006 and July 2022. Except for SNCF Réseau, all issues took place after 2013. These companies, which represent a diverse set of industries, have all leveraged their reputations as top-rated, US—or European-based borrowers to tap the Swiss franc debt markets regularly. During the first 21 years of the twenty-first century, they accounted for 15.2 percent of the CHF 141 billion borrowed by foreign companies, despite representing only 6.4 percent of the issuers.¹³ In addition to the Swiss franc debt presented in Table 8.4, some of these companies have additional debt tranches issued in other currencies. For example, Deutsche Bahn Finance GmbH has total debt of CHF 3.275 billion, EUR 2.9 billion, and AUD 180 million outstanding on the Swiss bond market.

Table 8.4 Top 15 Foreign Corporate Issuers of Swiss franc Debt, 2006 to July 2022 (CHF million)

The regional distribution of international borrowers that tap Swiss capital markets is relatively narrow. As Figs. 8.5 and 8.6 show, on average, 67.4 percent of total foreign public issuance originated in the European Union, United States, and Canada during the 2011 to 2021 period and 55.3 percent in 2021. The main driver of this decline was a reduced demand for Swiss franc debt by European borrowers given the Swiss franc’s appreciation relative to the euro. The European Union’s share of public borrowing in Switzerland reached an all-time high of 79 percent in 2011. This shift was due, in part, to the United States and Canada slashing their share of borrowing from 18 percent in 2009 to just 6 percent in 2010 as a result of the de-levering efforts after the financial crisis. Their share increased again in the following years due to the low-interest rates and reached a maximum of 35 percent in 2015. But the once prevailing majority of the European Union has shrunk considerably compared to other foreign borrowers.

Fig. 8.5

(Source Authors’ calculations based on data obtained from Swiss National Bank, Capital market borrowing of Swiss franc bond issues, https://data.snb.ch/en/topics/finma/cube/capmabond?fromDate=2011-Q1&toDate=2022-Q1&dimSel=D1(EU,UE,VSK,KZ,L,MOA,AN,E,T1),D0(E,R,NM) [Accessed on July 16, 2022])

Publicly floated bonds of foreign borrowers (in CHF millions): By country group (2011 to 2021)

Fig. 8.6

(Source Authors’ calculations based on data obtained from Swiss National Bank, Capital market borrowing of Swiss franc bond issues, https://data.snb.ch/en/topics/finma/cube/capmabond?fromDate=2011-Q1&toDate=2022-Q1&dimSel=D1(EU,UE,VSK,KZ,L,MOA,AN,E,T1),D0(E,R,NM) [Accessed on July 16, 2022])

Publicly Floated Swiss franc bonds of foreign borrowers: By country group, 2021

Swiss borrowing is dominated by banks, government entities (i.e., the Confederation, cantons, and municipalities), and, increasingly, the two Pfandbrief institutes. To reduce the chances of Switzerland experiencing a mortgage-led financial meltdown, such as the United States, Spain, and other countries experienced during the 2006 to 2012 period, FINMA approved, in June 2012, a set of mortgage financing standards proposed by the Swiss Bankers Association. Most important among them for borrowers were a minimum down payment percentage and the compulsory amortization of principal. For lenders, the new rules modified the nation’s Capital Adequacy Ordinance which requires banks to keep sufficient capital to back credit, market, operational, and further risks. These new rules took effect in July 2012. From 2013 on, the Basel III standards were gradually implemented into Swiss law, and capital requirements based on credit risks, market risks, and operational risks have been amended. The cornerstones concerning the capital requirements are increased risk sensitivity and less reliance on internal models. The next consultation for amending the Capital Adequacy Ordinance is scheduled for October 2022.¹⁴

Figure 8.7 shows domestic borrowers’ composition of publicly floated Swiss franc debt issues between 1999 and 2021. Confederation borrowing fell dramatically as a percent of total issues due largely to the 2003 introduction of Switzerland’s debt brake. From a peak of 53 percent of domestic Swiss franc public issues in 2003, it fell to just 10 percent in 2008 and 2009 and then increased to 21 percent in 2012, before reaching an all-time low of 6 percent in 2018. This small share resulted from a low refinancing need during this period and a total volume growth that was driven by the Pfandbrief institutes and banks in a booming real estate market. In 2021, the share jumped again to 17% due to higher debt refinancing. Confederation borrowing in the five years from 2017 to 2021 was only about 59 percent of its proportionate level in the years 1999–2016.

Fig. 8.7

(Source Swiss National Bank, Capital market borrowing of Swiss franc bond issues, https://data.snb.ch/en/topics/finma/cube/capmabond?fromDate=2021-Q1&toDate=2022-Q1&dimSel=D1(B0,K,G,P,VEGW,I,B1,V,UD,U,T0),D0(E,R,NM) [Accessed on July 19, 2022])

Publicly Floated Swiss franc Bonds of Swiss Borrowers, by Issuer Group: 1999 to 2021 (CHF millions)

In 2021, the top three borrower groups accounted for 79 percent of the domestic market’s outstanding public Swiss franc debt. In particular, the federal government accounted for 16.8 percent, the Pfandbrief institutes for 35 percent, and banks for 27.6 percent (see Fig. 8.8). Bank debt issues dropped to 8 percent of domestic public borrowing in 2009 during the global financial crisis. The collapse of asset prices forced many banks to recapitalize with equity instead of issuing new debt. This number was far below the 23-year (1999 to 2021) average of 19 percent. Bank debt issues rebounded sharply in 2010 to nearly a quarter of total borrowing once the economic growth picked up again, and then fell slightly after the Euro crisis before climbing to 27.6 percent in 2021 due to the low-interest rates and the booming economy. Another notable trend has been the growing role of the Pfandbrief institutes (i.e., Pfandbriefzentrale der Schweizerischen Kantonalbanken and Pfandbriefbank Schweizerischer Hypothekarinstitute) in the course of the real estate market development. We will return to the topic of Pfandbrief bonds later in this chapter. In 2022, financing conditions have deteriorated due to the inflation-induced interest rate increase and Russia’s invasion of Ukraine.

Fig. 8.8

(Source Swiss National Bank, Capital market borrowing of Swiss franc bond issues, https://data.snb.ch/en/topics/finma/cube/capmabond?fromDate=2021-Q1&toDate=2022-Q1&dimSel=D1(B0,K,G,P,VEGW,I,B1,V,UD,U,T0),D0(E,R,NM) [Accessed on July 19, 2022])

Publicly Floated Swiss franc Bonds of Swiss Borrowers, by Issuer Group: 2021

Debt financing reached a new dimension in March 2020 when the COVID-19 bridging loan program was launched. In response to the decreed shutdown due to the COVID-19 pandemic, a national financial aid package was tied within just a few days by a joint effort of the SNB, the Swiss banks, the Federal government, and FINMA. The goal was to ensure liquidity and unbureaucratic access to bridge financing at an interest rate of zero percent and for five years for companies hit by the crisis. Banks were encouraged to allocate “COVID-19 loans” up to CHF 500,000 to small and medium-sized companies (SMEs) based on a simple declaration.

To refinance these lending activities in the public interest, to keep potential credit risk off the balance sheet of participating banks, and to provide the banking system with additional liquidity, the SNB made a COVID-19 refinancing facility (CRF) available.¹⁵ Its purpose was to enable banks to draw covered loans from the SNB against this facility, in which mainly the Federal government served as a guarantor. “COVID-19 loans plus,” ranging from CHF 500,000 to CHF 20 million, received an 85 percent guarantee from the Federal government , hereby incentivizing banks to apply more care than with the COVID-19 loans .

Under the program that started on March 26, 2020, 138,000 loans with an aggregate volume of CHF 17 billion were granted. Many of these loans were paid back just a few months after the economy recovered. By February 2022, 112,000 loans with an aggregate volume of CHF 12 billion were still outstanding.¹⁶ It was part of the plan that some credit risks might arise given the cursory credit check . But having a simple and effective solution that helps to keep the real economy and the financial system afloat was seen to be way more critical. Despite some weaknesses in the lending process, the coordination between the different financial market players in designing and implementing an efficient and effective program in a concise period is exemplary.

The Size of the Swiss Franc Domestic and Foreign Debt Market

As of June 30, 2022, the aggregate amount of outstanding foreign and domestic Swiss franc debt listed on the SIX Swiss Exchange was CHF 575 billion, thereof CHF 142 billion in foreign Swiss franc bonds and approximately CHF 430 billion in domestic Swiss franc bonds.¹⁷ Based on this total volume of outstanding Swiss franc bonds, foreign issues accounted for 24.7 percent. This share is likely to decline in the years ahead because the fraction of new foreign bond issues has dropped remarkably after 2009, mainly due to a diminished issuing activity of European borrowers in the course of the Swiss franc’s appreciation relative to the euro. Between 2020 and 2022, this share was only 23 percent, on average (Fig. 8.9).

Fig. 8.9

(Source Authors’ calculations based on data obtained from Swiss National Bank , Capital market borrowing of Swiss franc bond issues, https://data.snb.ch/en/topics/finma/cube/capmabond?fromDate=2021-Q1&toDate=2022-Q1&dimSel=D1(B0,K,G,P,VEGW,I,B1,V,UD,U,T0),D0(E,R,NM) [Accessed on August 21, 2022])

Share of Foreign Bonds in Publicly Floated Swiss franc Bonds: 1990–2022

Based on the volume of outstanding Swiss franc bonds, Swiss federal government issues accounted for 17 percent and other domestic issues for 58 percent, as of June 2022 (see Fig. 8.10). In 2011, the total volume was CHF 573 billion. 2011 serves as a reference year after the financial crisis.

Fig. 8.10

(Source Authors’ calculations based on data obtained from SIX Group, Bond Explorer, Ibid. [Accessed on July 15, 2022])

Composition of Swiss public bonds outstanding, June 2022

The overwhelming majority (82 percent) of outstanding international Swiss franc public issues in 2022 were fixed-rate instruments, whereas floating rate instruments and equity-linked securities (convertibles and warrants) made up 18 percent of the market (see Fig. 8.11).¹⁸

Fig. 8.11

(Source Authors’ calculations based on data obtained from Bank for International Settlements (BIS), Statistics Switzerland Q1 2022, https://stats.bis.org/statx/srs/table/c3?c=CH&p=20221 [Accessed on July 18, 2022]. Full publications are available on the BIS website free of charge: www.bis.org)

Composition of Public International Swiss franc Medium—and Long-Term Debt Outstanding by Instrument Type: End 2011 and Q1 2022

Swiss Franc Public Issues

A helpful way to analyze the Swiss debt markets is by the size and nature of the most active Swiss franc public issues. The most developed and internationally active Swiss financial market is for debt instruments with medium- to long-term maturities. Domestically, the public market is used extensively by banks, the three levels of government, the two Pfandbrief institutes, utilities, the construction industry, industry firms like Roche and Novartis, infrastructure players, such as Swisscom (the leading Swiss telecom provider) and Eurofima (a supranational organization headquartered in Basel that finances the development of rail transportation in Europe).¹⁹ A cocktail of convenient and flexible bond arrangements is available and issue costs (interest and commissions) are among the lowest in the world. Fig. 8.12 shows the composition of Switzerland’s note and bond issues from 1995 to 2021. “Domestic” refers to issuers domiciled in Switzerland, “foreign” to issuers domiciled outside of Switzerland. A bond is labeled “public” when listed on the exchange and “private” if this is not the case. The absence of domestic and foreign private placements after 2003 was because the SNB stopped tracking them when the Revised National Bank Act came into force on May 1, 2004.²⁰

Fig. 8.12

(Source Authors’ calculations based on data obtained from Swiss National Bank , Capital market borrowing of Swiss franc bond issues, https://data.snb.ch/en/topics/finma/cube/capmabond?fromDate=2010-Q1&toDate=2022-Q1&dimSel=D1(T0),D0(E) [Accessed on July 18, 2022])

Composition of Swiss franc Note and Bond Issues, 1995 to 2021 (CHF millions)

Switzerland’s high saving rate offers a continuous flow of medium- and long-term funds to the domestic credit market, thereby providing borrowers with markets that have considerable breadth and depth. Domestic borrowers favor straight, fixed-rate issues with maturities between 5 and 12 years, but the most common issue maturity has been 10 years, which is also close to the maturity of an average issue (10.7 years).²¹ On a weighted-basis, the average maturity is 10.1 years. Fig. 8.13 shows the maturity distribution in the Swiss franc bond market since 1999.

Fig. 8.13

(Source Authors’ calculations based on data obtained from SIX Group, Bond Explorer, Ibid. [Accessed on July 15, 2022])

Distribution of bond maturities at issuance in the Swiss franc bond market 1999–2022

Switzerland is the borrowing destination for many nations. In July 2022, 10 countries accounted for almost 77 percent of total outstanding public Swiss franc foreign debt (see Table 8.5).²² The foreign bond market in Switzerland has thrived, largely because it has been exempted from the Swiss stamp duty since 1993. As a result, these debt instruments have become particularly attractive to foreign investors, especially from countries with no, or inadequate, double taxation agreements with Switzerland. Despite these advantages, the volume has come down massively over the past decade, from CHF 329 billion in June 2012 to CHF 142 billion in July 2022.

Table 8.5 Outstanding Foreign Swiss franc Debt on SIX Swiss Exchange by Country as of June 30, 2022

Swiss Franc Private Placements

Private placements or notes are unadvertised, high-denomination securities issued (usually through syndicates) to a limited number of investors, with very competitive issuance costs.²³ They are interesting alternatives for investors who are willing to place funds in multiple units of CHF 50,000 for medium- to long-term maturities. The yields on these instruments are usually higher than those on more marketable bonds. To provide a secondary market, issuing banks are typically willing to acquire customer notes at prevailing yield levels. Customarily, coupon payments occur annually, and investors wishing to purchase such notes buy them during the underwriting period.

As mentioned earlier in this chapter, the market for private placements seems to have declined since the mid-1990s. It is difficult to know precisely how active this market is today because the SNB stopped tracking it on May 1, 2004, when the National Bank Act entered law. Due to a change in the repo system that occurred at the same time, private placements were not eligible as collateral in repo transactions anymore.²⁴ Even before this change, several significant factors marginalized the importance of private placements , which accounted for CHF 14.5 billion of the market (24 percent of all domestic and foreign debt issues) in 1996 but fell to just CHF 8.9 billion (10 percent of issues) in 2003 (see Fig. 8.12). We will return to the causes of these developments later in this section.

Foreign private placements date back to the late 1960s and early 1970s. Unlike public bonds, Swiss law does not deal specifically with such notes. Instead, they fall under the general framework of securities law in the Swiss Code of Obligations.²⁵ The absence of bureaucratic restrictions made these placements very popular. It kept costs low, but they lost some of their lusters when Switzerland amended its Banking Act on February 1, 1995, thereby abandoning its strict international capital controls. These changes made public debt more attractive and reduced the relative advantage of private placements .

Under the revised Act, the SNB replaced the authorization requirement for foreign entities issuing Swiss-franc-denominated securities with an information duty. For banks, a mandatory notification on all prospective bond and note issues was set into force. The SNB’s mandatory notification was a valuable financial indicator in exceptional periods when sizeable international capital flows might threaten Swiss monetary policy. Yet, even this requirement appeared as too demanding. On May 1, 2004, Switzerland abandoned this information duty entirely with the enactment of the National Bank Act.²⁶

Usually, private placement notes are not printed (for cost reasons) and, therefore, are held in dematerialized form, in the issuing banks, for the benefit of investors. In contrast to the United States, Switzerland has no strict limitation on the number of purchasers (maximum of 35 in the United States)²⁷ of privately placed notes. Moreover, no prospectus is required.²⁸ Although the number of potential investors to whom a private placement can be offered is not clearly defined, it should be limited to a relatively small circle of potential customers. Following a conservative best practice, these notes should be offered to 20 or fewer potential investors (regardless of their sophistication) to qualify as a private offering. But this rule has been criticized as being too stringent.²⁹ For example, the European Union’s Prospectus Directive sets the limit at 150 investors per member state, and the Swiss Federal Act on Collective Investment Schemes (CISA) holds that collective investment schemes in the form of SICAV (a collective investment scheme with variable capital), regardless of the number of potential investors, do not qualify as public offerings.³⁰

Earlier in this chapter, Fig. 8.12 profiled the diminished relative importance of Switzerland’s private placement market. Much of the decline was due to the foreign segment’s sharp retreat from this market between 1995 and 2003. While myriad factors spirited the change, four are particularly important, namely (1) the Amended National Banking Act, (2) the Importance of Liquidity, (3) the Asian Financial Crisis, and (4) Indirect Effects.

Amended National Banking Act

Simplicity (less effort and lower costs) is one of the primary motivations for borrowers to issue private placement debt. Issuers are willing to pay dearly to avoid the regulations and requirements of public issues. Therefore, as public debt issuance in Switzerland became less demanding, the appeal of private placements diminished. For example, in February 1995, the SNB ended its authorization requirements for foreign entities issuing Swiss-franc-denominated securities and replaced it with an information duty, making public issues more attractive relative to private issues.³¹

Importance of Liquidity

Another major factor fueling the decline of foreign private placements was the increased importance of liquidity, which was driven both directly and indirectly by process and product innovations at Swiss exchange. The introduction of fully-automated bond trading on August 16, 1996, directly reduced the appeal of private debt placements because they could not be easily traded using the new system.³² The introduction of US dollar-denominated bonds on July 31, 1998, and the introduction of euro-denominated bonds to the SIX’s Swiss franc bond segment in 1999 precipitated an easing of Switzerland’s (transfer ) stamp tax , which further increased the importance of liquidity. This critical revision of the stamp tax , which came into force on April 1, 1999, made active trading of public bonds more attractive by eliminating the tax requirement imposed on foreign counterparties that engage in transfers of foreign debentures with Swiss counterparts, either directly or through intermediaries.³³

Asian Financial Crisis

Outside of Switzerland, perhaps the single most important factor causing the shrinkage of foreign private placements in Switzerland was the Asian Financial Crisis of 1997,³⁴ which had significant direct and indirect consequences. An immediate effect was an increased aversion by Asian companies, in general, and Japanese companies, particularly, to finance their operations in a currency as strong as the Swiss franc . Until 1997, Japanese companies were leading borrowers of Swiss francs , but the drop in demand was sudden and sharp. In 1996, Japanese entities issued private placement notes worth more than CHF 4.5 billion, which accounted for nearly 34 percent of all foreign private Swiss franc borrowing. By contrast, in 1998, these same companies issued just CHF 343 million, representing a meager 7.1 percent of borrowing.³⁵

The Asian financial crisis also reduced foreign reliance on nonstandard debt instruments in the private market. As a result, the popularity of equity-linked private placement instruments collapsed as lenders sought less risky investments. Proof of these effects is in the numbers. Foreign private issues with warrants attached fell from CHF 4.78 billion in 1996 to just CHF 1.80 billion in 1997 before falling out of use entirely in 1998.³⁶ Meanwhile, foreign convertible private placements fell from CHF 2.05 billion in 1996 to CHF 800 million in 1997 to CHF 117 million in 1998. Although they represented just 2.4 percent of foreign private issues in 1998, convertibles continued to be used beyond that point as they provided some upside potential combined with downside protection.³⁷

Indirect Effects

The crisis also indirectly reduced the size of Switzerland’s foreign private placement market (and those of other major financial centers). Many Asia–Pacific nations used the financial calamity as a reason to build their domestic bond markets.³⁸ As a result, domestic corporations could avoid the double mismatch of currency and maturity on their balance sheets—a combination that compounded the Asian damages in the 1997 crash. The rapid market growth in the Asia–Pacific region (excluding Japan, Australia, and New Zealand) of 61.4 percent between 1995 and 2000 in contrast to only 18.6 percent for all Bank for International Settlements markets shows the success of these initiatives. Consequently, demand for Swiss private placements declined, as many Asian companies could satisfy their borrowing needs at home. Swiss franc private placements from this region fell from CHF 603.6 million in 1996 to CHF 274 million in 1997 before falling to CHF 27 million in 1998 and then disappearing entirely.

Hybrid Securities and Convertible Bonds

In the early 1990s, healthy stock markets increased the popularity of convertible bond issues and bonds with warrants. Between 1990 and 1994, convertibles and warrants represented 1.5 percent and 8.4 percent, respectively, of all domestic public issues (with fixed-rate issues accounting for the other 90.1 percent).³⁹ This trend reversed in the mid-1990s with the decline of Japanese interest in these financial instruments . Between 1995 and 2007 (the last year for which the SNB reported public issuance data by bond category), these two equity -linked categories represented only 4.1 percent of all issuance , with fixed-rate and other⁴⁰ issues accounting for 95.7 percent and 0.2 percent, respectively.⁴¹ Notably, warrants accounted for just 0.9 percent over this period. With capital markets getting more efficient and providing many ways of generating payoff structures, there seemed to be no market for warrant bonds anymore. Since 2002, there have been no further public issues of bonds with warrants .

The development has been different for convertible bonds that give the instrument holder the right to convert the bond into equity (within the contractual terms). In contrast to bonds with warrants (where the bond continued to exist after the warrant was exercised), the convertible bond does not persist as a bond after its conversion into equity. The conversion is attractive in case of favorable market conditions since investors may exercise their right to convert the bond into shares. Convertible bonds, therefore, provide upside potential. At the same time, they grant some downside protection as investors may receive the redemption value of the bond in case the stock price is too low for conversion. Because this right benefits investors, convertible bonds pay a slightly lower coupon rate compared to straight bonds. This difference depends on the likelihood that investors will convert the convertible bond sometime in the future. Typically, low but promising stock market valuations and low-interest rates are favorable conditions for issuing convertible bonds.

In most years, listed convertible bonds play a minor role on the bond market. In 2008, however, the Swiss market has seen a record volume of CHF 21.3 billion in convertible bonds being issued, mainly driven by the refinancing of UBS and Credit Suisse during the financial crisis. UBS alone issued CHF 19 billion in mandatory convertible bonds (MCNs) in 2008. In contrast to typical convertible bonds, the conversion of MCNs is mandatory at some predefined point in time. As a consequence, their coupon rate typically is quite high because economically, MCNs can be seen as equity. Therefore, the markets also price in the risk premia of equity.

The years after this exceptional period have again shown modest volumes of listed convertible bond issues. In July 2022, 10 companies had Swiss franc convertible bonds listed with a total amount issued of CHF 4.3 billion.⁴² In addition, four companies had contingent capital bonds issued and listed with an aggregate volume of CHF 3.8 billion.⁴³ This corresponds to 0.74 percent and 0.66 percent, respectively, of the aggregate amount issued on the Swiss bond market.

Government Bond Market

The Swiss government bond market is relatively small compared to most other developed nations. For years, the federal government ran budget surpluses, thereby avoiding the need to borrow. Still, in the early 1990s, deficits rose sharply.⁴⁴ At the end of 1994, the federal debt stood at CHF 76 billion, up nearly 40 percent from CHF 55 billion in 1992. This trend was fueled by increased demands from federal pension funds and Confederation-affiliated enterprises, such as the Swiss post and telephone company (PTT until 1998) and the Swiss railroad company (SBB).⁴⁵ Even though Switzerland’s Constitution mandates balanced budgets at the Confederation level, the undisciplined fiscal policy ignoring this principle resulted in rising deficits during the 1990s. This background produced overwhelming support for a more effective expenditure rule. As a result, on December 2, 2001, 85 percent of Swiss voters approved Constitutional provisions for the Swiss national debt brake (see above). This measure, which took full effect in 2007, has provided the bite necessary for Switzerland to aggressively pursue fiscal policies that resulted in low debt levels—especially when compared to other countries (see Table 8.6). At the same time, as explained earlier in this chapter, additional expenditure is possible in exceptional situations, such as the COVID-19 pandemic .⁴⁶

Table 8.6 International Comparison of Gross Financial Liabilities Relative to GDP : 2021 versus 2011 (Percent of GDP , ranking based on 2021 figures)

At times of heightened awareness by financial investors regarding sovereign fiscal discipline, Swiss government bonds have been considered a particularly riskless asset, characterized by low credit premia and hence low yields. Swiss Confederation bonds are exclusively denominated in the domestic currency. The Confederation publicly lists its bonds on the SIX Swiss Stock Exchange for investors to buy and sell in a transparent and regulated environment. The federal government issues these interest-bearing securities with maturities up to fifty years, while most issues have maturities between 15 and 30 years.⁴⁷ The average maturity of the currently traded Swiss government bonds at the time of their issue was 24.8 years. Regularly, additional tranches are issued that are fungible with earlier issues.⁴⁸ In 1980, the federal government began issuing bonds using a Dutch auction system.⁴⁹ They are issued on an almost monthly basis,⁵⁰ and the closing date for subscription is the second Wednesday of the issue month.⁵¹

As with all things in life, one should be careful of one’s wishes. Switzerland seems to have brought government creep under control, but, at the same time, significant future reductions in the absolute and/or relative amount of government security issues are likely to exacerbate liquidity problems in Swiss debt markets and challenge notions of what a risk-free Swiss franc interest rate is. While the nation is not walking a razor’s edge—because it has been able to reverse an unsustainable trend in federal financing—serious attention must be paid, in the future, to answering fundamental questions dealing with the proper (or desired) role of government debt in the Swiss franc market.

Pfandbriefe

Pfandbriefe⁵² are an essential source of real estate loan refinancing. These instruments are a special form of mortgage -backed bonds, but have to be clearly distinguished from instruments not issued by one of the two Pfandbrief institutions . Pfandbriefe are issued by two government-authorized and controlled financial institutions —Pfandbriefzentrale der Schweizerischen Kantonalbanken (PBZ) and Pfandbriefbank Schweizerischer Hypothekarinstitute (PBB). Switzerland created PBZ and PBB to provide Swiss residents with real estate mortgages at stable and affordable interest rates .⁵³ They are perfect examples of financial practicality and wisdom. Rather than having each of Switzerland’s many mortgage banks issue its mortgage -backed securities , PBB and PBZ consolidate and issue securities backed by many banks’ mortgages , deriving significant cost savings through economies of scale.

Swiss Pfandbrief Institutes

Switzerland’s Pfandbrief institutions are efficient organizations. PBZ outsources all of its operations to Zürcher Kantonalbank, and PBB operates with fewer than 10 employees. Having a common cause, the main difference between the two is their membership. PBB was founded in 1930 for non-cantonal mortgage-issuing institutions, and PBZ was founded the following year for cantonal banks.⁵⁴ By law, only cantonal banks can become members of PBZ. In the case of PBB, any bank can gain membership so long as it is headquartered in Switzerland and approved for membership by the PBB’s directors.

Pfandbriefe, which in English means pledge letters, are mostly standardized, fixed-rate securities backed by first liens on Swiss real estate mortgage loans. Swiss law (Pfandbriefgesetz, PfG) and Swiss ordinances (Pfandbriefverordnung, PfV)⁵⁵ give PBB and PBZ exclusive rights to issue them. As evidence of its staying power and stable heritage, since the Act’s passage in 1930, PfG has been modified only four times, each with only marginal changes.

Pfandbrief securities have become increasingly more important for refinancing mortgages. Today, they finance approximately 13.4 percent of all Swiss mortgages and are issued as either public bonds through banking syndicates or private placements by the Pfandbrief institutes.⁵⁶ In 2010, the share was 9.1 percent. Public issues are listed on the SIX Swiss Exchange , and whenever possible, existing issues with terms (e.g., maturity and yield) identical to those desired are reopened. The maturities of these Pfandbrief securities run from 3 to 30 years, with an average maturity of 14 years.

Growth of Pfandbrief securities is somewhat limited by a 2 percent equity-to-Pfandbrief liability requirement put on PBB and PBZ by PfG (Art. 10). Furthermore, new issue sizes are determined by the smaller of member banks’ demand for Pfandbrief loans or investors’ (i.e., Pfandbrief holders) demand for securitized mortgage debt. New issues average CHF 576 million and range from CHF 100 million to CHF 1 billion. The annual issue volume has been CHF 13.1 (2021), 13.5 (2020), 12.8 (2019), and 11.7 billion (2018).⁵⁷

Figure 8.14 provides an overview of the Pfandbrief process:

• 1. It starts when the mortgagee (e.g., Homeowner B) takes a loan from Bank C, based on the purchase price or refinance value of a home (A). In return, the bank receives a lien on the property, which prohibits the mortgagee from transferring the property’s title without permission from the bank until the mortgage debt is extinguished.

• 2. In need of funding, Bank C uses this mortgage obligation as collateral for a loan from a Pfandbrief institution (D). In contrast to other nations, where the mortgage changes possession, in Switzerland, borrowing banks with known customers and therefore recognized risks keep these loans on their balance sheets and manage them.

• 3. The Pfandbrief institutions then issue securities to investors (E), mainly Swiss pension funds, institutional investors, banks, investment funds, and some retail investors.

Safety of Pfandbrief Securities

Swiss Pfandbrief institutions have enjoyed an unblemished record of zero investor losses since their inception more than 90 years ago. The quality of these securities is so high that the SNB permits their use as collateral in central bank-related repo transactions. Moody’s Aaa Stable credit rating for Swiss Pfandbriefe also speaks favorably of these debt instruments’ safety, as well as the Pfandbrief process, the strong legal framework that supports it, and the rules and ordinances that define and regulate Pfandbrief issues.⁵⁸ Legal protections that apply to Pfandbrief securities limit many of their issue terms, such as percentage coverage, qualifying underliers, maximum loan-to-value ratios, and valuation rules. These rules also designate the federal regulator (FINMA ), who is responsible for monitoring and overseeing Pfandbrief institutions .

Significant additional investor protection springs from the structure of the Swiss Pfandbrief model (see Fig. 8.14). Pfandbrief loan obligations are not only backed by the cash flows from underlying mortgages but also by the property’s proprietor, member banks (and all their assets because Pfandbriefe remain on their books), and the Pfandbrief institutions themselves.⁵⁹ In the event of default by a debtor bank, investors, and the Pfandbrief institutes have a preferential claim on the loan collateral . Other creditors can claim only what remains in the cover pool after Swiss Pfandbrief creditors are fully satisfied.

Fig. 8.14

(Source Authors’ representation. The concept was adopted from Credit Suisse, White Paper No. 9—Swiss Covered Bonds: Investors’ Flight to Quality, May 27, 2009, https://pfandbriefbank.ch/sites/de/assets/File/Research_Berichte/20090527%20Investors%27%20flight%20to%20quality%20(Credit%20Suisse%20AG).pdf [Accessed on July 28, 2022])

Collateralization Provisions in the Swiss Pfandbrief Model

Among the most significant additional layers of protection are⁶⁰:

Covered loans: By Swiss law (PfG), the principal and interest payments on Pfandbrief securities must be covered 100 percent by Swiss-based mortgages.

Cover Pool:

• Management: The collection of mortgages backing a Pfandbrief issue is called the “cover pool.” All the assets within this pool must be listed in a Swiss cover register (i.e., Pfandregister). Mortgages listed in the cover pool stay on the banks’ books and are managed by the banks themselves, with supervision and monitoring by the Pfandbrief Institutions. PBZ, the institute of cantonal banks, has its cover pool actively managed by the member banks, most of which benefit from a state (i.e., cantonal) guarantee.⁶¹ PBB, which serves the non-cantonal banks, has an electronic “cover pool,” whose value is updated and evaluated daily, with these valuation assessments made independently from the methods used by member banks.

• Composition and diversification: Swiss cover pools consist primarily of residential properties whose default rates are considerably lower than commercial property mortgages. Pfandbriefbank’s cover pool consists only of residential mortgages.⁶²

• Redress: The cover pool is monitored daily. Nonperforming or otherwise impaired loans must be pruned and replaced, by the lender, with performing loans that can restore the pool’s valuation to pre-stressed levels. Moreover, banks must provide supplementary collateral if interest income from the mortgages falls below the pool’s total interest expenses.⁶³

• Overcollateralization: This safety measure increases the chances that negative valuation shocks can be absorbed. Cover pool assets must exceed Pfandbrief loans made to PBB and PBZ member banks by 8 and 15 percent, respectively.⁶⁴ The relatively high overcollateralization requirement for the PBZ compensates for the fact that, unlike the PBB, its cover pool is decentralized, hence making it more prone to underestimating collateral requirements. In Article 26, the law on Pfandbriefe requires a minimum overcollateralization of 5 percent for non-members.

• Separation: Mortgages in the cover pool must be separated from other mortgages in banks’ portfolios to prevent the comingling of assets.

Down payments: Residential mortgages require down payments of at least one-third (i.e., loan-to-value ratios equal to or less than 66.7 percent on first-grade mortgages),⁶⁵ and commercial loans require 50 percent down.⁶⁶

Slight risk of simultaneous defaults: Even under worst-case scenarios, it is hard to imagine circumstances under which Pfandbrief investors might incur losses. For this to happen, the Pfandbrief institutions, banks, and borrowers would have to default, and the value of the land would have to plummet in value.

Minimum financial risks: New Pfandbrief securities must be denominated in Swiss francs, and their terms must match the maturity and repayment profiles of member banks’ loans from the Pfandbrief institutions. This restriction eliminates (or mitigates) currency, interest, liquidity, and duration risks.⁶⁷

No pre-payment risk: Member-bank borrowers who wish to prepay their loans must purchase outstanding Swiss Pfandbriefe with a serial number that matches their loans (i.e., not with cash), thereby extinguishing both an asset and a liability on the Pfandbrief institutes’ balance sheets.

A second level of due diligence: The Pfandbrief institutions thoroughly check the eligibility of cover assets, thereby providing a second set of underwriting eyes on the underlying assets.

Small counterparty risk: Investors face minimal counterparty risk because their transactions are with the Pfandbrief institutions, not the banks. Therefore, investors’ claims are backed not only by the cash flows from the underliers but also by the full faith and credit of the Pfandbrief institutions’ equity, earnings on invested equity funds, and implicit government guarantees, which created these financial intermediaries.

As a result of these many layers of protection and the conservatism built into the Swiss Pfandbrief model, Switzerland’s mortgage bond market is safe in any sense of the word. When the 2007–2009 financial turmoil heightened concerns about counterparty risk and, in turn, nearly froze the interbank money markets, Switzerland’s Pfandbrief model proved to be a critical mechanism for providing liquidity across the Swiss banking system. Bolstered in part by a flight to quality, the Swiss Pfandbrief market remained liquid throughout the crisis, as evidenced by low Asset Swap (ASW) spreads compared to those in Europe and the United States.⁶⁸

There is concern that a substantial increase in the issuance of Swiss Pfandbrief securities could jeopardize the institutes’ capitalization.⁶⁹ For instance, if the CHF 2 billion Pfandbriefe private placement loan to UBS following the September 2008 collapse of Lehman Brothers had turned sour, these institutes could have faced significant liquidity risk at maturity . Several measures mitigate this risk , such as subordinated debt, which can now serve as capital for temporary Pfandbrief transactions . In addition, significant private placements require approval from FINMA , and lenders have agreed to allow the Pfandbrief institutes to stretch their repayment schedule under extreme conditions. Swiss Pfandbriefe will likely continue their safe-haven role and, as a result, maintain tight asset swap spreads.

Size and Growth of the Pfandbrief Market

Total outstanding Pfandbrief debt exceeds Confederation liabilities. In July 2022, there were about 273 publicly issued Swiss Pfandbriefe outstanding worth CHF 157.3 billion, compared to total Confederate debt equal to nearly CHF 96.4 billion end of 2020.⁷⁰ From 1995 to 2021, these securities experienced an average annual growth rate of 6.6 percent, and, in recent years (especially since enactment of the Confederate debt brake ), they have outpaced new issues of federal debt.⁷¹ During the past decade, the annual growth rate was 8.5 percent. In 2021 alone, PBB and PBZ issued Swiss Pfandbriefe amounting to CHF 13.1 billion, and the net volume was CHF 8.4 billion.⁷²

Figure 8.15 provides an overview of the growth and composition of Pfandbriefe since 1995. In general, supplies are limited relative to potential domestic and foreign demand, which has made these securities largely unavailable to foreign investors. Foreign holdings have been further discouraged by Swiss withholding taxes.⁷³ A notable exception to the lackluster foreign involvement in this market is a growing demand for Pfandbriefe as a financing instrument by foreign-controlled banks operating in Switzerland. Even though this growth in demand has been strong, the low base from which it started has only translated into a diminutive 2.7 percent share of the market in 2021.⁷⁴

Fig. 8.15

(Note Due to partly missing data for Cantonal Banks , Regional Banks and Savings Banks , and Raiffeisen Banks during 2011–2014, these datapoints were interpolated Source Authors’ calculations based on data obtained from Swiss National Bank. For 2015–2021: Loans from central mortgage bond institutions, https://data.snb.ch/en/warehouse/BSTA/cube/BSTA@SNB.JAHR_K.BIL.PAS.APF.DPZ?facetSel=toz_bsta_bankengruppe(begriff_bg_a25)&dimSel=KONSOLIDIERUNGSSTUFE(K),INLANDAUSLAND(T,I),WAEHRUNG(CHF,EUR,T),BANKENGRUPPE(A25)) [Accessed on July 28, 2022])

Loans of the two Swiss Pfandbrief institutes by category of banks: 1995–2021, in CHF millions

Switzerland’s financial institutions have tried to tap the latent foreign demand for securities backed by mortgages on Swiss real estate by creating new instruments. Between 2009 and 2014, UBS launched a series of covered bonds, issued as Eurobonds in euros (EUR), Norwegian krone (NOK), and United States dollars (USD), and backed by Swiss mortgages (not Pfandbriefe). The several issues done by January 2011 amounted to EUR 5.75 billion (equivalent to CHF 8.535 billion), reaching a maximum Swiss franc equivalent of CHF 16.1 billion in 2013 and declining since then. In 2018, the outstanding volume was CHF 4.6 billion; in May 2022, only one series was left of NOK 700 million (equivalent to CHF 93.2 million). UBS’s covered Swiss real estate bonds are relatively riskier than Pfandbriefe because this market is unregulated, lacks legal protections afforded to Swiss Pfandbriefe, and terms are negotiated strictly between issuers and buyers.⁷⁵ Therefore, they do not carry the high-quality imprimatur of Swiss Pfandbriefe .

Sustainable Bonds

In recent years, investor demand has shifted toward activities following environmental, social, and governance (i.e., ESG) standards, excluding non-compliant investments. With the launch of Green Bonds, SIX Swiss Exchange introduced a new bond type in 2014. The first issue of CHF 350 million was placed on the market by the European Investment Bank on February 4, 2014. By July 2022, 80 bonds labeled “green bonds” had been issued with a total market volume of CHF 22.3 billion.⁷⁶ To be flagged as “green bonds ” by SIX, they must comply with the criteria used in the CBI Green Bond Methodology.⁷⁷

In 2019, Raiffeisen issued a Sustainability Bond of CHF 100 million. Currently, it is the only security in this segment. Since 2020, five Sustainability-Linked Bonds got listed from three companies: Novartis Finance (in 2020, CHF 1.85 billion), Holcim Helvetia Finance Ltd (two instruments in 2022 with a total volume of CHF 425 million), and Axpo Holding AG (two instruments in 2022 with a total volume of CHF 500 million). In 2021, the Central American Bank for Economic Integration (CABEI) issued the first Social Bond over CHF 200 million. In 2022, the Canton of Basel-Stadt followed with an issue of CHF 110 million. According to the International Capital Market Association’s (ICMA) principles⁷⁸ that serve as a guideline, sustainability-Linked Bonds include a commitment from the issuer to achieve specific sustainability goals within a predefined timeline.⁷⁹

The volumes in these four segments (i.e., Green, Social Bond, Sustainability, and Sustainability-Linked) are relatively small. Relative to the total bond volume listed on SIX Swiss Exchange, Green Bonds account for 2.7 percent of the instruments but only 0.62 percent of the issued volume in SIX’s CHF, EUR, and USD bond segments. For Social Bonds, Sustainability Bonds, and Sustainability-Linked Bonds, the figures are 0.07 percent, 0.03 percent, and 0.17 percent, respectively, for the number of instruments, and 0.011 percent, 0.003 percent, and 0.1 percent, respectively, for the listed volume. These numbers also reflect that both the average and median issue sizes of bonds in these four new segments are substantially below the average issue size of other bonds on SIX Swiss Exchange (Fig. 8.16).

Fig. 8.16

(Note The bond universe is limited to bonds denominated in CHF, EUR, and USD. This corresponds to 92 percent of all bond securities issues on SIX Swiss Exchange Source Authors’ calculations based on data available from SIX Group, Bond Explorer, Ibid. [Accessed on July 18, 2022])

Average issue sizes and median issue sizes (secondary axis) in CHF million

Figure 8.17 shows that Swiss Franc is the dominating currency for Green Bonds, Social Bonds, and Sustainability Bonds. This indicates that the yet-small investment market so far is mostly domestic. At the same time, the proportions in the case of Social Bonds, Sustainability Bonds, and Sustainability-Linked Bonds are strongly biased, given that there have been only seven issues in these three segments altogether.⁸⁰

Fig. 8.17

(Note The bond universe is limited to bonds denominated in CHF, EUR, and USD. This corresponds to 92 percent of all bond securities issues on SIX Swiss Exchange Source Authors’ calculations based on data obtained from SIX Group, Bond Explorer, Ibid. [Accessed on July 18, 2022])

Sustainable Bonds by currencies

Conclusion

Switzerland’s debt market showcases the valuable turntable function the nation plays in global financial markets. Foreign investors use Swiss debt markets to diversify their assets with the strong and stable Swiss franc currency, and borrowers (domestic and foreign) use it for the low-cost, long-term funding it provides to businesses, governments, and supranational organizations. Since 2007, the Swiss Confederation has scaled back its borrowing activities, and, at the same time, domestic Pfandbrief institutes have taken a more prominent role. This trend will likely continue as safety and fiscal conservatism attract more voter (and government) attention. Nevertheless, it will always be challenging to balance the short-term need for additional expenditures in extraordinary situations, such as the COVID-19 pandemic, against the long-term interest of fiscal conservatism.

While Switzerland’s domestic debt market, as a whole, is vibrant, the short-term portion is underdeveloped, mainly due to the nation’s stamp tax and the tendency of Swiss borrowers (governments, corporations, and banks) to issue relatively little short-duration debt. Yet, this is also changing as global financial realities pressure Swiss (and other) politicians and voters to understand and respect the relationship between tax structures that are not internationally competitive and waning economic growth. In the face of volatile global markets, rising inflation rates, and global unrest, robust demand from investors for Swiss-franc-denominated debt instruments will likely keep interest rates low by comparison and spur more significant borrowing. Ongoing sovereign debt problems, which have been plaguing some European Monetary Union members, in conjunction with continuing pressure on the reserve currency status of the US dollar, are likely to boost the status of Switzerland’s relatively small, yet increasingly important, debt markets.

For more than a century, Swiss-franc-denominated financial obligations have enjoyed the faith and confidence of savers and investors worldwide. This confidence was not won overnight but from years of efficient, high-quality, and steady performance. The country will need traditional pillars of strength, such as high domestic saving rates, low inflation, free and open capital/trade markets, rule of law, political stability, respect for confidentiality, secure private property rights, reasonable tax rates, and sensible budget deficit levels to support future debt market growth. If there is a main future attraction, it is likely to be safety, as evidenced by the loss-free record of Pfandbrief investors during their 90-year history. Frontiers will expand by continuing to offer financial instruments that meet the risk-return profiles of borrowers and lenders. In addition, the speed and accuracy of transacting business will need to stay competitive. To succeed, Switzerland’s debt markets will constantly have to reinvent themselves. Competition in capital markets benefits everyone by more efficiently managing and allocating the trillions of dollars in financial assets and liabilities that change hands each year.