Buy Side Drives Back-to-Back SEF Volume Records

By Colby Jenkins, TABB Group

Originally published on TABB Forum 

While regulatory factors continue to push interest rate swap volumes on-SEF, the return of volatility is driving natural demand for swaps.

On-SEF notional volumes for cleared interest rate swaps (IRS) in October peaked at $2.9  trillion, beating the previous month’s record by just more than $83 billion, setting a new all-time record for monthly SEF trading activity (see Exhibit 1, below). This total represents a 31% jump above the previous YTD 2014 average and a 95% increase from the 2013 monthly notional average traded.

Exhibit 1: Cleared IRS Monthly Notional Volumes, (Ex-FRA) 

Source: TABB Group, ISDA 

TABB Group has tracked trading data since SEF trading went live a little more than a year ago. Within this period, we have consistently observed a pronounced, expected uptick in IRS activity correlating to conventional quarterly IMM dates. March, June, and September all were record-breaking months in 2014. With the exception of May (which may have been driven by no-action relief expirations for package trades), months in between all saw significant dips in activity. What is unique about October is that it is the first time in 2014 in which a new record for activity was set the month following the quarterly IMM month.  

The question is: What drove October’s surge? Two significant regulatory factors were at play in October. The October Federal Open Market Committee (FOMC) signaled the end of QE3, a stimulus program that has in many ways provided a six-year safety net for the market. The uncertainty the end of QE3 will surely generate, coupled with the eventual hike in interest rates, will likely mean a long-awaited return of volatility and, with it, a natural demand for swaps. The strong uptick in October may be the first wave of this new demand.

Similar to the volume spike that occurred in May, impending no-action relief expiration for package transactions involving a Made-Available-to-Trade (MAT) swap also may have been a factor in October’s record volumes. On Nov. 15, the final no-action relief for package transactions involving a MAT swap and a future (invoice spread) will expire. What we might be seeing in October is a slight easing-in on the part of investors looking to continue their use of these contracts.

Market share data for October support the case for the buy side’s growing demand influence. Taking the average between the two most recent record-breaking months (October and September) and comparing to an average across July and August, Dealer-to-Customer volume grew by just under 50%. This growth is a significant contrast to the 37% overall growth in notional volume among Dealer-to-Dealer (D2D) SEFs for the same period (see Exhibit 2, below). The strong growth in client flow in the context of the lesser increase in dealer activity indicates that the buy side’s appetite for IRS clearly has room to grow.

Exhibit 2: D2D vs D2C Recent Notional Growth 

Source: TABB Group, Clarus FT 

Looking to the rest of this year, Nov. 15 represents a significant step forward for the SEF market, regardless of whether the final no-action expiration will have a significant notional impact. Can the market keep this momentum? Data suggests that the market has much room to grow, although the next couple of months historically are a time of stagnation. 

We are only weeks away from concluding the initial Made-Available-to-Trade (MAT) implementation process. As we step into the next stage of the process, there is considerable pressure on SEF operators and regulators alike to responsibly expand the current scope of MAT mandates – although the real pressure is on the regulators to discern which contracts are truly ready, as struggling SEFs have economic incentives to push as many mandates though as possible.