Activity in the US$493trn swaps market continued to fragment along geographic lines through 2015, with over 91% of cleared euro interest rate swaps in the interdealer market transacted between European counterparties in December, according to analysis by ISDA.
The latest study, based on monthly regional clearing data from LCH.Clearnet, shows that the proportion of euro IRS traded solely between European dealers has increased from 70% in September 2013, just prior to the introduction of new rules that forced US market participants to trade most vanilla interest rate swaps over registered swap execution facilities.
Swaps liquidity pools have split along US and non-US lines in response to fractured implementation of new regulatory requirements that were agreed by G20 leaders at the Pittsburgh summit in 2009.
US SEF trading rules came into force in October 2013, requiring all “US persons” to trade the most liquid benchmark swaps maturities in US dollars, euros, sterling and yen over electronic platforms registered with the CFTC. Similar efforts in Europe will not take effect until January 2018 when new swaps trading rules are implemented as part of MiFID II.
Cross-border activity in the interdealer euro IRS market has declined dramatically as European counterparties avoid transacting with US firms that are subject to SEF-trading rules that form part of Dodd-Frank reforms.
Monthly notional volume of euro IRS transactions between US and European interdealer counterparties fell to just €232bn in December 2015, down from €652bn prior to the introduction of US SEF rules. Over the same period, activity between European counterparties has increased to €3.05trn from €2.27trn.
While the shift coincides with the onset of SEF trading in the US, there may be other factors at work as fragmentation of liquidity pools appears to be restricted to euro interest rate swaps.
While regional liquidity pools also exist in US dollar interest rate swaps, that market has not seen the same level of fragmentation. Transactions between European and US dealers in the US interdealer market has seen only a small decline to 47% from 51% over the same period.
In the European market for US dollar swaps, US dealers continue to be the largest regional counterparty. Cross-border flows between US and European counterparties in that market made up just over half of the US$1.11trn of activity in December 2015.
ISDA previously noted that the global nature of the euro interest rate swap market might make it more prone to fragmentation, while the US IRS market is typically more US-centric.
