Actualize Consulting’s Eunice Bet-Mansour shares the results of her analysis of the economics of derivatives prices in a centrally cleared / SEF executed environment versus a non-cleared trading regime. Read on to learn more about the comparative methodology and findings.
Since the passage of Dodd-Frank in 2010, discussions in the derivatives industry about the costs of clearing and on-SEF execution have revolved around systems, connectivity, data, reporting and compliance. In parallel, there has been somewhat scant and muted speculation about another cost of clearing and on-Swap Execution Facility (“SEF”) execution—namely, whether clearing will push up the price at which derivatives trades are executed. We present here a first look at the comparative economics of derivatives prices under alternative market structures—a clearing cum SEF trading regime vis a non-cleared trading regime. Using aggregated data from SwapsInfo we show that, on average, clearing without SEF trading renders derivatives more expensive relative to a non-cleared regime. Simultaneously, we also demonstrate that a derivatives trading regime which combines clearing with SEF execution renders derivatives cheaper on average than a clearing regime without SEF execution.
SwapsInfo.org is an informational service provided by International Swaps and Derivatives Association (“ISDA”) wherein swaps trade data reported to the DTCC and the Bloomberg Swap Data Repository (BSDR) are aggregated and presented on a daily basis. As of October 2014, SwapsInfo aggregates vanilla par fixed-floating interest rate swaps and FRAs in various currencies as well as USD and EUR Index credit default swaps.
Herein, we undertake an analysis of the economics of the five-year (“5Y”) USD vanilla fixed-float swaps only. Several reasons account for this narrow focus. First, the USD swaps market is the largest, deepest and the most liquid swaps market in the world. Second, the 5Y vanilla fixed-float swap is one of the most liquid buckets on the USD yield curve with a bid-offer spread of one-quarter of a basis point, 0.25bps. Given the depth and liquidity of the USD swaps market, our expectation is that differences in swaps rates for cleared 5Y USD vanilla swaps executed simultaneously on and off SEF would be minimal, i.e. near-zero. We also expect minimal differences in five-year USD fixed-float swap rates between Cleared On-/Off-SEF trades and Uncleared On-/Off-SEF trades executed simultaneously.
Methodology
Price, trade count and notional data for the 5Y USD vanilla fixed-float swap are reported on Swapsinfo for the following time series:
- – Cleared On-SEF: Daily aggregated time series October 2, 2013 through October 22, 2014
- – Cleared Off-SEF: Daily aggregated time series October 2, 2013 through October 22, 2014
- – Uncleared Off-SEF: Daily aggregated times series October 2, 2013 through October 22, 2014
- – Uncleared On-SEF: Aggregated time series but highly sporadic from October 2, 2013 through October 22, 2014
The Uncleared On-SEF time series for the 5Y USD vanilla Fixed-float swap is not considered given the sporadic nature of the data. We then transform the remaining three time series into a new set of time series of differences as follows:
- – Time Series I: Cleared Off-SEF minus Cleared On-SEF—5Y USD Fixed-Float Vanilla Swap Rate
- – Time Series II: Cleared Off-SEF minus Uncleared Off-SEF—5Y USD Fixed-Float Vanilla Swap Rate
- – Time Series III: Cleared On-SEF minus Uncleared Off-SEF—5Y USD Fixed-Float Vanilla Swap Rate
Each of the above time series has 265 observations.
Results
(I) Time Series I: Cleared Off-SEF minus Cleared On-SEF—5Y USD Fixed-Float Vanilla Swap Rate
Chart I and Exhibit I present analyses of Time Series I. Chart I exhibits the differentials in the 5Y Cleared USD Vanilla Fixed-Float Swap rates executed On-SEF and Off-SEF. This time series has a mean of 1.27 basis points and standard deviation of 3.90 basis points.
This aggregated data demonstrates that while on average On-SEF Cleared USD Vanilla Swaps are less costly than Off-SEF Cleared USD Vanilla Swaps, the price differential of Cleared On-SEF from Cleared Off-SEF trades is highly volatile. A histogram of this same time series in Exhibit I demonstrates the high frequencies of large price differentials.
(II) Time Series II: Cleared Off-SEF minus Uncleared Off-SEF AND Time Series III: Cleared On-SEF minus Uncleared Off-SEF—5Y USD Fixed-Float Vanilla Swap Rate
The purpose of these time series is to analyze the economics of Uncleared trades vis those of Cleared trades. Chart II shows the 5Y vanilla swap rate differentials between Uncleared Off-SEF trades and
Cleared On- and Off-SEF trades. Both time series exhibit high volatility. They also exhibit that on average Uncleared trades are more economical than Cleared Off-SEF Trades: Cleared Off-SEF 5Y Vanilla swap rates are on average 1.33 basis points higher than the Uncleared 5Y vanilla swap rates. However, the Cleared On-SEF trades are on average only 0.06 basis points higher than the Uncleared 5Y Vanilla rates, indicating minimal price differentials in this category. However, note that the standard deviation of the differential between the Cleared Off-SEF 5Y Vanilla swap rates and the Uncleared 5Y swap trades is 5.81 basis points while that of the Cleared On-SEF 5Y Vanilla swap rates and the Uncleared 5Y swap trades is 6.1 basis points.
Conclusions
Our analysis of aggregated data for the highly liquid and deep USD swaps market demonstrates high volatility in swap rate differentials between 5Y Cleared and Uncleared Fixed-Floating swaps and in swap rate differentials between Cleared On-SEF and Cleared Off-SEF trades. While on average there is minimal differential between Cleared On-SEF and Uncleared trades, Cleared Off-SEF trades are more expensive than Uncleared trades, pointing to inefficiency in the Cleared Off-SEF market structure. This inefficiency in the Cleared Off-SEF regime is also seen by the significantly higher average price of trading Cleared Off-SEF swaps relative to Cleared On-SEF swaps.
As noted above, this analysis is a first look at the price of clearing. Further analysis of the economics of clearing requires disaggregated timing-adjusted data for each of the trading regimes considered herein.
