SEF Momentum Fleeting as Trading Experiences Volatility
By Anthony J. Perrotta, Jr. and Colby Jenkins, TABB Group
Originally published on TABB Forum
On-SEF volumes plummeted in November, reminding us that one year in, SEF trading may be out of its infancy, but growing pains are still very much part of the market’s present and future.
Momentum is a fickle friend; at its heart, it’s fleeting. Such was the case on display in the OTC swaps market in November, when notional trading activity failed to sustain the momentum witnessed September and October.
Average daily notional volumes for Off-SEF Cleared IRS increased dramatically in September (+20%) as the market emerged from the summer doldrums. The market held onto those levels through October, before plummeting significantly in November (-25% MoM), as depicted in Exhibit 1, below. As of publication, average daily volumes in December looked to be rebounding, averaging $143 billion per day (+21%).
On-SEF cleared IRS trading in November peaked at just over $1.8 trillion, down 36% from the record high of $2.9 trillion in October (Exhibit 2, below). Some of the decline could be attributed to a shorter trading month (20 days versus 23), but average daily trading volumes fell as well, from $127 billion to $93.4 billion.
Exhibits 1 and 2: Monthly Notion SEF Volumes (IRS)/ Monthly Notional Off-SEF Volumes (IRS)
Ex-FRA
Source: TABB Group, ISDA
Credit Default Swap Index volumes On-SEF also declined precipitously in November. October’s record-setting volume ($911 billion) quickly became an aberration, as notional transacted fell to $312 billion, a decline of almost 66% compared to the year’s prior average (Exhibit 3, below). Again, the shorter trading month is a factor when looking at aggregate trading volumes, but as with the IRS market, average daily volumes fell, from $40 billion to just under $16 billion.
Exhibit 3: Index CDS Monthly Notional SEF Volumes
Source: TABB Group, ISDA
Underscoring the lack of activity On-SEF in November was the tremendous uptick in Off-SEF trading for uncleared interest rate swaps – $2.88 trillion was traded away from SEF venues in November, a 41% jump from the year’s average to date. Looking specifically to the average daily traded, we see that activity Off-SEF for Cleared IRS rose 54% compared to the 2014 average (Exhibit 4, below). In reality, this total is likely greater than the total reflected in the SDR data, given that block trades (which make up a considerable portion of uncleared Off-SEF trading) are reported at the block threshold minimum.
Exhibit 4: Average Daily Uncleared IRS Off-SEF Notional Volume
Ex-FRA
Source: TABB Group, ISDA
Despite the recent volatility in terms of overall swap activity, there has been consistency throughout the year for trends relating to how they are trading.
Average trade sizes have consistently tracked downward for On-SEF trades (Exhibit 5, below) and upward for Off-SEF trades for much of 2014. For cleared On-SEF trades, we have seen a more than doubling in actual trade count when looking to 2013 vs. the past few months. This, in tandem with a general increase in overall notional activity for On-SEF trading, even more specifically for USD plain vanilla IRS, suggests an overall increase in turnover.
Conversely, Off-SEF trading had only seen moderate notional growth until November, with no uptick in overall trade counts month to month, which accounts for the increase in average trade size – which is even more pronounced with USD IRS traded Off-SEF (Exhibit 6, below).
Exhibits 5 and 6
Ex-FRA
Source: TABB Group, ISDA
Looking to 2015, there are many roadblocks remaining for the emerging SEF market. Package trade no-action relief, which was set to expire in November, was pushed back to 2015, and deep technological issues around straight-through processing are still largely unresolved. One year in, SEF trading may be out of its infancy, but growing pains are still very much part of the market’s present and future.
In our recent TABB Group report, “U.S. Fixed Income Market: Industry Trends & Drivers 2014,” we explore some of these trends governing the evolution of swaps trading in the U.S. market, as well as the larger trends within the fixed income ecosystem as a whole. We illustrate the changes underway in terms of the structural components of the market and dive into some of the idiosyncrasies present in the rates, credit, and swaps markets to gain a better understanding of what might await market participants once the winds of change subside and the storm passes.