2021: Brexit, no equivalence for pan European OTC Interest Rate Swaps markets, what the data shows so far…

Following our initial flash analysis in mid-January (available here) we have received a great deal of interest for a more detailed breakdown of the activity in the global OTC interest rate derivative markets post Brexit.

First, to recap why there was so much interest, the transitional period ended on 31 December with no relief for European Union (EU) firms on the derivatives trading obligation (DTO) from the European Commission (EC) and only limited adjustments from the United Kingdom (UK). Despite largely identical rules, no equivalence was granted between jurisdictions. This left many firms with conflicting and incompatible DTOs in the EU and the UK and no apparent option other than to trade the relevant derivatives on a US Swap Execution Facility (SEF), or in Singapore. US firms remained subject to the CFTC's Made Available to Trade (MAT) requirements.

Current position:

• EU firms must meet the EU DTO by trading certain OTC Interest Rate Swaps (IRS) on an EU MTF/OTF or an 'equivalent' venue, currently limited to US SEFs and Singapore based venues,
• UK firms must meet the UK DTO by trading certain IRS on an UK MTF/OTF or an 'equivalent' venue, currently limited to US SEFs and Singapore based venues (with some limited relief)
• US firms must meet the MAT requirements by trading certain IRS on a US SEF or an exempt foreign swap trading venue, currently; UK MTFs/OTFs, EU MTFs/OTFs and Singapore based venues.

This means that EU, UK and US firms can access global on-venue liquidity but, UK firms cannot access EU venues (except in some special cases where temporary relief is available) and EU firms cannot access UK venues. This has created some specific challenges:

• An EU firm can only trade certain IRS subject to both the EU and UK DTOs with a UK firm on a venue that allows both firms to comply with their local DTOs.
• A UK branch of an EU firm is subject to both the UK and the EU DTO.

IHS Markit has assessed the January 2021 data processed by IHS Markit's MarkitWire platform to assess the impact of Brexit on single currency interest rate swaps (IRS) trading for the three currencies subject to the DTO in the EU and the UK and the MAT requirements in the US, analysing market share in EUR, GBP, and USD swaps: all, on venue, dealer-to-dealer, dealer-client, a proxy for DTO/MAT, cleared as well as total volumes and notional traded. In this analysis we distinguish between UK and EU venues.

How did January 2021 compare to the prior 6 months?

EUR swaps

EUR: All Swaps

• The EU MTF/OTF share has grown from less than 10% in July 2020 to a quarter as of January 2021
• The UK MTF/OTF share has fallen from just under 40% in July 2020 to just over 10% as of January 2021
• The SEF share has grown from less than 10% in July 2020 to approximately 20% as of January 2021
• Off facility has remained fairly consistent.

On-venue EUR swaps

• The EU MTF/OTF share has grown from just over 10% in July 2020 to approximately 45% as of January 2021
• The UK MTF/OTF share has fallen from just over 70% in July 2020 to approximately 20% as of January 2021
• The SEF share has grown from approximately 15% in July 2020 to approximately 35% as of January 2021

EUR Dealer to Dealer Swaps

• The EU MTF/OTF share has grown from approximately 5% in July 2020 to just over 30% as of January 2021
• The UK MTF/OTF share has fallen from approximately 50% in July 2020 to approximately 15% as of January 2021
• The SEF share has grown from approximately 5% in July 2020 to approximately 15% as of January 2021
• Off facility has remained fairly consistent.

EUR Dealer to Client Swaps

• The EU MTF/OTF share has grown from approximately 10% in July 2020 to approximately 15% as of January 2021
• The UK MTF/OTF share has fallen from approximately 15% in July 2020 to approximately 7% as of January 2021
• The SEF share has fallen from approximately 14% in July 2020 to approximately 11% as of January 2021
• Off facility has grown from approximately 60% in July 2020 to approximately two thirds as of January 2021

EUR Swaps subject to a trading obligation (DTO/MAT[1])

• The EU MTF/OTF share has grown from just over 6% in July 2020 to approximately 38% as of January 2021
• The UK MTF/OTF share has fallen from approximately 57% in July 2020 to approximately 16% as of January 2021
• The SEF share has grown from just over 5% in July 2020 to approximately 17.5% as of January 2021
• Off facility has remained fairly consistent.

EUR Cleared[2]Swaps

• The EU MTF/OTF share has grown from approximately 7% in July 2020 to just over 25% as of January 2021
• The UK MTF/OTF share has fallen from just over 40% in July 2020 to approximately 12% as of January 2021
• The SEF share has grown from approximately 11% in July 2020 to just over 20% as of January 2021
• Off facility has remained fairly consistent.

GBP swaps

• The EU MTF/OTF share has grown from approximately 1.5% in July 2020 to approximately 6% as of January 2021
• The UK MTF/OTF share has fallen from approximately 25% in July 2020 to just over 20% as of January 2021
• The SEF share has grown from less than 20% in July 2020 to approximately 23% as of January 2021
• Off facility has remained fairly consistent.

On-venue GBP swaps

• The EU MTF/OTF share has grown from approximately 3% in July 2020 to approximately 13% as of January 2021
• The UK MTF/OTF share has fallen from approximately 55% in July 2020 to approximately 42% as of January 2021
• The SEF share has grown from approximately 40% in July 2020 to approximately 45% as of January 2021

GBP Dealer to Dealer Swaps

• The EU MTF/OTF share has grown from approximately 2% in July 2020 to approximately 10% as of January 2021
• The UK MTF/OTF share has fallen from approximately 40% in July 2020 to just over 25% as of January 2021
• The SEF share has grown from approximately 10% in July 2020 to just under 25% as of January 2021
• Off facility has remained fairly consistent.

GBP Dealer to Client Swaps

• The EU MTF/OTF share has grown from approximately 1% in July 2020 to approximately 2% as of January 2021
• The UK MTF/OTF share has grown slightly from approximately 14% in July 2020 to approximately 15% as of January 2021
• The SEF share has fallen from approximately 20% in July 2020 to approximately 13% as of January 2021
• Off facility has remained fairly consistent.

GBP Swaps subject to a trading obligation (DTO/MAT[3])

• The EU MTF/OTF share has grown from approximately 3.5% in July 2020 to approximately 4.5% as of January 2021
• The UK MTF/OTF share has fallen from approximately 55% in July 2020 to just under 30% as of January 2021
• The SEF share has grown from approximately 16% in July 2020 to just under 40% as of January 2021
• Off facility has increased from approximately 25% in July 2020 to approximately 30% as of January 2021

What stands out in the raw data is that the number of trades has fallen sharply across all categories excluding SEF which had a small increase. This could be due to firms trading more non-MAT products, some firms sitting out or more likely due to firms switching from GBP-LIBOR trading (which is subject to DTO/MAT) to SONIA (which is not) as part of the IBOR reform efforts. This doesn't mean that the SONIA swaps aren't traded on a venue, they typically are, it is just that they aren't technically subject to DTO/MAT. A discussion for another day perhaps…

GBP Cleared[4]Swaps

• The EU MTF/OTF share has grown from approximately 2% in July 2020 to approximately 6.5% as of January 2021
• The UK MTF/OTF share has fallen from just under 30% in July 2020 to approximately 22% as of January 2021
• The SEF share has grown from approximately 22% in July 2020 to approximately 24% as of January 2021
• Off facility has remained fairly consistent.

USD Swaps

All USD swaps

• The EU MTF/OTF share has grown from approximately 0.5% in July 2020 to approximately 2% as of January 2021
• The UK MTF/OTF share has fallen from just under 10% in July 2020 to approximately 6% as of January 2021
• The SEF share has grown from just under 40% in July 2020 to just under 50% as of January 2021
• Off facility has fallen from just over half to just over 40%.

On-venue USD swaps

• The EU MTF/OTF share has grown from approximately 1% in July 2020 to approximately 4% as of January 2021
• The UK MTF/OTF share has fallen from approximately 19% in July 2020 to approximately 11% as of January 2021
• The SEF share has grown from approximately 80% in July 2020 to approximately 85% as of January 2021

Dealer to Dealer USD Swaps

• The EU MTF/OTF share has grown from <1% in July 2020 to approximately 3% as of January 2021
• The UK MTF/OTF share has fallen from approximately 10% in July 2020 to just over 5% as of January 2021
• The SEF share has grown from just over 40% in July 2020 to just under 60% as of January 2021
• Off facility has fallen from just under half to just over a third.

Dealer to Client USD Swaps

• The EU MTF/OTF share has grown from <1% in July 2020 to approximately 1.5% as of January 2021
• The UK MTF/OTF share has risen from approximately 8% in July 2020 to just under 10% as of January 2021
• The SEF share has remained fairly consistent.
• Off facility has remained fairly consistent.

USD Swaps subject to a trading obligation (DTO/MAT[5])

• The EU MTF/OTF share has grown from approximately 0.5% in July 2020 to approximately 3.5% as of January 2021
• The UK MTF/OTF share has fallen from approximately 14% in July 2020 to approximately 9% as of January 2021
• The SEF share has grown from approximately 57% in July 2020 to approximately 63% as of January 2021
• Off facility has remained fairly consistent.

USD Cleared[6]Swaps

• The EU MTF/OTF share has grown from approximately .5% in July 2020 to approximately 2.5% as of January 2021
• The UK MTF/OTF share has fallen from 10% in July 2020 to just over 6% as of January 2021
• The SEF share has grown from just over 40% in July 2020 to approximately 50% as of January 2021
• Off facility has declined from approximately 47% to approximately 40%.

These shifts in market share have created a more geographically fragmented market in EUR and GBP and more geographically concentrated market in USD on SEFs. What is unclear is whether this fragmentation has impacted liquidity.

How have swap volumes and notional traded held up during the transition?

Swaps markets are seasonal so comparing volumes between different months is misleading. For example, January is typically a month with robust trading activity, whereas December can be heavily impacted by the holiday period. To compare 'like-for-like' we looked at January each year from 2016 through to 2021.

All EUR Swaps

• EUR IRS trading is down in January 2021
• EUR volumes are down some approximately 15% YoY[7] and approximately 10% versus the prior 5 years' average[8]
• EUR notional traded is down approximately 26% YoY and approximately 30% versus the prior 5 years' average

It is possible that this could be explained by a combination of some smaller firms being unprepared for the transition, some firms sitting on the fence, and there could be a general lack of demand for OTC interest rate swap hedging due to the current low and stable interest rate environment. Ultimately this will become clearer as we move through the first quarter and have more data on activity as the market evolves.

All GBP Swaps

GBP IRS market is less clear

• GBP volumes are showing a sharp decline of 38% YoY and fell 3% versus the prior 5-year average but it is in line with 2019 and higher than January 2016-2018.
• GBP notional traded is down 43% YoY but grew 68% versus the prior 5 years' average
• The apparent YoY decline could be seen to have been driven by an outlier month in January 2020

It is possible that this could be explained by a combination of some smaller firms being unprepared for the transition, some firms sitting on the fence, and there could be a general lack of demand for OTC interest rate swap hedging due to the current low and stable interest rate environment. Ultimately this will become clearer as we move through the first quarter and have more data on activity as the market evolves. However, the GBP numbers also seem impacted by particularly robust trading last January both in terms of volume and notional traded, which may have been related to UK formally leaving the EU at the end of 31 January 2020.

All USD Swaps

USD IRS market is relatively flat

• USD swap volumes fell 3% YoY but grew 5% versus the prior 5-year average.
• USD swap notional traded fell 13% YoY and fell 10% versus the prior 5-year average.

The USD data shows a much more measured YoY reduction in volumes and notional traded at just 3% this could be driven by different interest rate expectations but could also be because the USD IRS market has not been disrupted.

EUR, GBP and USD are by far the biggest swap markets making up ~60% of the global market[9]. However, for comparison we looked at rest of the world (ROW) as a single bucket to try to measure general non-DTO/MAT currencies volumes in general.

All Other Currency Swaps

ROW swap volumes fell 15% YoY but grew 4% versus the prior 5-year average.

Conclusion

OTC derivative markets are global in nature and very agile. Trading liquidity in OTC interest rate derivatives tends to concentrate on a currency by currency basis, liquidity begets liquidity. However, the combination of a relatively hard Brexit for financial services, the lack of EU - UK equivalence (or a progressive detailed financial services agreement) combined with the equivalence available from both the EU and the UK to use US SEFs has had the effect of driving some former UK venue volume to SEFs and a number of EU venues, primarily in Amsterdam and to a lesser extent in Paris. There is also generally reduced activity both in terms of volumes and notional traded in January 2021 compared to 2020. This could be explained by low volatility, caused by a low and stable interest rate environment. However, the impact varies by currency and there are nuances by market segment. Ultimately this should become clearer as we move through the first quarter and have more data on the activity as the market evolves.

Notes:

1. The calculations are generally, except as otherwise stated based on (i) all new single currency interest rate swaps; Including IRS & OIS (fixed versus floating), fixed versus fixed swaps and basis swaps (floating vs floating) referencing all floating rate options (indices), supported by IHS Markit's MarkitWire platform
2. Swaps markets are seasonal so comparing volumes between different months is misleading. For example, January is typically a month with robust trading activity, whereas December can be heavily impacted by the holiday period. To compare 'like-for-like' we looked at January each year from 2016 through to 2021
3. There is a small quantity of US MTF/OTF trades, these are immaterial and have been ignored for this analysis.
4. There is at least one UK based SEF, to protect client confidentiality the UK SEF trades have been classified as SEF rather than being classified separately. Therefore, SEF throughout the analysis means all SEFs including the US SEFs plus a(ny)UK SEF(s)

[1] The full set of EU, UK DTO and US MAT rules are complex. As a proxy for subject to a trading obligation we have used Product IRS (fixed float), Tenor DTO/MAT, Spot starting (i.e. excluded non-spot but also excluded IMM which is DTO/MAT), Roll frequency 3m or 6m and Floating Rate Option (index) DTO/MAT.

[2] For the avoidance of doubt these are not just swaps cleared in the EU, they are swaps cleared at any of the OTC IRS clearing houses globally.

[3] See footnote 1

[4] See footnote 2

[5] See footnote 1

[6] See footnote 2

[7] YoY comparison is January 2021 versus January 2020

[8] Comparison versus the prior 5-year average is January 2021 versus the average of January 2016, 2017, 2018, 2019, 2020

[9] This calculation is based on (i) all new single currency interest rate swaps; Including IRS & OIS (fixed versus floating), fixed versus fixed swaps and basis swaps (floating vs floating) referencing all floating rate options (indices), supported by IHS Markit's MarkitWire platform…

Posted 10 February 2021 by Kirston Winters, Managing Director − MarkitSERV, IHS Markit

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