25 July 2014

ISDA: Revisiting cross-border fragmentation of global OTC derivatives: mid-year 2014 update

Over-the-counter derivatives markets have fragmented along geographical lines since the start of the swap execution facility (SEF) regime in the US on October 2, 2013. ISDA’s latest research shows further fragmentation since February 2014, based on an empirical analysis of cleared derivatives data.

ISDA’s latest report provides an update to the January 2014 paper to analyse how the MAT determinations have affected trading activity, and specifically whether they have resulted in further fragmentation in global derivatives markets. To measure the effects on cross-border relationships, we collected monthly regional clearing data from LCH.Clearnet between January 2013 and May 2014 for US dollar and euro interest rate swaps (IRS). These swaps were chosen given their regional significance, liquidity and price transparency attributes.

Findings reveal the market for euro IRS continues to grow more fragmented. According to LHC.Clearnet data:

• The average volume of euro IRS transacted between European dealers as a percentage of total euro IRS volume was 75% between January 2013 and September 2013. In the period following the implementation of the SEF rule – October 2013 through January 2014 - this average rose to 90%.
• The MAT determinations appear to have exacerbated euro IRS market fragmentation. The average European-to-European interdealer volume as a percentage of total euro IRS volume increased to 93% between February 2014 and May 2014.
• The average cross-border volume of euro IRS transacted between European and US dealers as a percentage of total euro IRS volume was 25% from January 2013 to September 2013. In the period following the implementation of the SEF rule, this average fell to 9% between October 2013 and January 2014.
• The MAT determinations drove average European-to-US interdealer volume even lower, to 6%, between February 2014 and May 2014.
• European dealer volume with Canadian dealers in the market for euro IRS has steadily increased since August 2013, while US dealer volume with Canadian dealers has trended lower. The market for US dollar IRS is US-centric, whereas the market for euro IRS has a more global character and is thus more prone to fragmentation. Like euro IRS, European dealers primarily trade US dollar IRS with other European dealers, albeit to a lesser degree.
• US dollar IRS volume between European dealers increased after the October 2013 SEF rule came into force, but normalised in the months following the February 2014 MAT determinations.
• SEFs continue to be US-centric liquidity pools, with reported US dollar IRS trades accounting for over 70% of IRS volume traded on these platforms.
• The MAT determinations have also affected the average percentage of euro IRS trading on SEFs. Trading in euro-denominated IRS decreased once the MAT determinations came into force – from 13% to 9% – as liquidity continued to move away from US persons.

 

Full ISDA Research Note

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