21 January 2014

ISDA: Cross-border fragmentation of global OTC derivatives

Market participants reported that cross-border liquidity has fragmented along US person and non-US person lines. Continued regulatory uncertainty has resulted in greater price volatility and a shifting in the nature of trading from cleared to bilateral risk management.

This analysis builds on ISDA's earlier work and aims to empirically characterise the composition of and changes to cross-border pools of liquidity following the October 2, 2013 implementation date. To accomplish this, ISDA uses monthly 2013 clearing and reporting data for US dollar and euro interest rate swaps (“IRS”) for its use-case. These swaps were chosen given their regional significance, liquidity and price transparency attributes.

ISDA findings reveal:

• The market for euro IRS has appeared to fragment significantly. Volumes of cleared Euro IRS between European and US dealers dropped 77 per cent since October 2013 indicating a breakdown of cross-border trading relationships.
• Restricted access to US persons likely influenced changes to the trading process, such as reduced trading or a temporary shift to bilateral risk management, resulting in a 47 per cent decrease in total euro IRS cleared volume from January 2013.
• While changes in euro IRS trading were pronounced, changes in US dollar trading of IRS were less evident.
• US dealers continued to trade US dollar IRS with European and US dealers in fairly consistent volumes throughout the 2013; European dealers traded the majority of their US dollar IRS with other European dealers throughout the year.

Swap Execution Facilities (SEFs) are currently US-centric liquidity pools as reported US dollar IRS trades dominated over 70 per cent of IRS volume traded on SEFs.

ISDA-webpage

Please click on the PDF link below for the full report

FN reporting: US swap rules cause cross-border 'breakdown'

A lack of meaningful cross-border coordination between US and EU regulators presented a number of difficulties for firms that were unsure of their obligations as the US rules came into force. Europe is further behind in its implementation of the G20 swap market reforms, with many of its rules set for introduction this year.

Confusion over whether EU dealers could trade with US counterparties after the introduction of SEFs may have also led some firms to temporarily resort to trading privately with each other, according to ISDA.

The ISDA survey also highlights an overall drop in trading volume of euro interest rate swaps processed through clearing houses throughout 2013. The report said: “This change indicates a possible unwillingness of European dealers to transact with US dealers, creating an exclusively European inter-dealer pool that is separate from other sources of liquidity". Fragmentation of liquidity in this way risks greater price volatility, a concentration of risk and less transparency, according to ISDA.

Full article (FN subscription required) 

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