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20 December 2016

ISDA: Derivatives market analysis: interest rate derivatives

This report addresses the effects of clearing and compression on interest rate derivatives by adjusting reported notionals in order to provide a clearer estimate of derivative market trends.

Twice a year, ISDA analyses interest rate derivatives notional outstanding data reported by the Bank for International Settlements (BIS) in order to illuminate market trends. The bank’s most recent analysis was released in November 2016. This publicly reported data does not describe several notable aspects of the derivatives market. For example, risk metrics associated with derivatives cannot be conveyed through notional figures. Additionally, the effects of clearing and compression skew BIS totals.

The BIS publishes derivatives notional outstanding data on a semiannual basis. Its most recent survey report combines end-June 2016 results from semiannual as well as a triannual surveys, which results in data points from a broader universe of dealers. Although these statistics can provide fairly granular information on swap market trends, our report brings to light the impact of two countervailing factors: clearing and compression. Clearing increases notional outstanding, as a single bilateral trade is reported as two separate transactions within the BIS statistics (one between party A and the clearing house and one between party B and the clearing house). The BIS semiannual notional outstanding data is not amended for this double counting of cleared transactions. This research adjusts for this effect to provide an estimate of the proportion of total IRD notional outstanding that is currently cleared, as well as the proportion of clearable IRD notional outstanding that is cleared.

In contrast, compression has the opposite effect by acting to reduce notional outstanding through the cancelling or ‘netting’ of offsetting trades. In recent years, as balance sheet real estate has become scarcer, more of the swaps market has been compressed. The BIS figures are reported after compression has occurred, which makes it difficult to draw any conclusion about underlying derivatives market activity.

The effects of clearing and compression skew publicly reported derivatives notional outstanding data. Clearing acts to increase reported notional outstanding, as a single bilateral transaction is counted as two cleared trades once novated to a central counterparty. In contrast, compression reduces notional outstanding, which can make it seem like fewer trades are taking place. Recently, publicly reported figures reflected an 8.9% increase in outstanding volume during the six months to June 30, 2016 – the first increase in two and a half years. At this time, we estimate the underlying market before clearing and compression increased at a slower pace of 5.5%. Lower growth in the estimated figure was the result of a faster pace in clearing combined with a slower pace in portfolio compression. While both measures increased over the six months to end-June 2016, it remains to be seen whether the pace of clearing will continue to accelerate quickly as compression takes a breather.

Full analysis

© ISDA - International Swaps and Derivatives Association

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