Liquidity Continues to Fragment for Interest Rate Swaps Markets

By Colby Jenkins, Tabb Group

Originally published on Tabb Forum

The aggressive overhaul of the U.S. swaps market with respect to the scheduled implementation of European reforms continues to drive cross-border liquidity fragmentation for certain swaps markets. Today, U.S. dealer volume in euro-denominated interest rate swaps has all but disappeared.

The aggressive overhaul of the U.S. swaps market with respect to European reform implementation schedules has indeed been a major driver of cross-border liquidity fragmentation for certain swaps markets, recent interdealer clearing data published by the International Swaps and Derivatives Association (ISDA) and compiled by LCH.Clearnet SwapClear suggests.

Trading activity for euro-denominated interest rate swaps (IRSs) within the U.S. market has declined precipitously since October 2013 – the first month of SEF trading. The data shows that prior to SEF implementation, a total notional value of EUR 900 billion was transacted on average each month during 2013 within the U.S. market. U.S. interdealer volume on average accounted for 33% of the total volume traded.

Today, that volume has all but disappeared. In the second half of 2015, euro-denominated IRS activity among U.S. dealers dropped significantly. An average of EUR 325 billion was traded each month in euro-denominated IRSs within the U.S. market; of that volume, only 6% was attributable to U.S. interdealer flow (see Exhibit 1, below).

Exhibit 1: U.S. Market for Euro-Denominated IRS

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Source: LCH.Clearnet SwapClear, Cross-Border Fragmentation of Global Interest Rate Derivatives: Second Half 2015 Update (ISDA, May 2016), TABB Group

Exhibit 2, below, represents the global market for euro-denominated swaps and reflects the clearest point of demarcation between the pre- and post-SEF landscape in terms of dealer activity:

Exhibit 2: Global Market for Euro-Denominated IRS (Market Share)

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*U.S.-to-Asian/Canadian & European-to-Asian/Canadian Interdealer

Source: LCH.Clearnet SwapClear, Cross-Border Fragmentation of Global Interest Rate Derivatives: Second Half 2015 Update (ISDA, May 2016), TABB Group

Prior to the implementation of the SEF mandate in October 2013, volume transacted among European counterparties accounted for roughly two-thirds of the global euro-denominated IRS market. As of April 2016, the percentage of that global market for euro-denominated swaps captured by the exclusively European dealer liquidity pool has grown to 91%. U.S. dealers, on the other hand, represent less than 1% of the total market today, compared to an average of more than 10% prior to SEFs going live.