OSTTRA has assessed the Q2 2021 data processed by our MarkitWire platform to evaluate the impact of Brexit on single currency interest rate swaps (IRS)[i] trading for the three currencies subject to the derivatives trading obligation (DTO) in the EU and the UK and the CFTC’s Made Available to Trade (MAT) requirements in the US. We analysed the trading venue geographical market share for EUR, GBP, and USD swaps.
For additional background on the drivers for these shifts see our initial flash analysis in mid-January (available here), and our January review (available here), Q1 2021 review (available here) and our joint report with Deloitte (available here) entitled “European capital markets: The regulatory considerations for banks as they move beyond Brexit”.
To recap the drivers, the transitional period ended on 31 December with no relief for European Union (EU) firms on the 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 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 when UK banks face EU clients who cannot access a SEF)
- 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 except; 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, which means an EU bank cannot face a UK client on an EU nor UK venue
- A UK branch of an EU firm is subject to both the UK and the EU DTO.
How did Q2 2021 compare?
EUR: All Swaps
After the dramatic moves in late 2020 and early 2021, we have seen additional movement from the UK to the US venues in Q2 2021 with UK MFTs/OFTs falling from 10% in March to 9% in April, and 8% in May and June 2021 and SEFs increasing from 19% in March to 22% in April and May and 24% in June 2021, while EU venues have remained largely flat at around 26%.
Q1 versus Q2: The SEFs’ Q2 share was 23% up from 18% the UK venues’ share was 8% down from 11% and the EU share was flat at 26%.
GBP Swaps
After the significant moves in late 2020 and early 2021 with SEFs overtaking UK MTFs/OTFs to become the biggest on-venue market. Q2 has been stable with the only noticeable trend a small decrease in EU venue market share from 5% in March and April to 4% in June 2021 but this still remains much higher than the 1% in mid-2020, but now half the 8% we saw in December 2020. SEFs have remained consistent with their March level throughout Q2 2021. The UK MTFs/OFTs saw a jump in June to 22% the highest level in 2021 thus far, but this could be a one-month anomaly at this stage. We will check back on this in our Q3 review.
Q1 versus Q2: The SEFs’ Q2 share was 29% up from 25% the UK venues’ share was flat at 20% and the EU share was down at 4% from 5%.
USD Swaps
After the small but significant moves in late 2020 and early 2021 with UK MTFs/OTFs market share falling from 10% to 5%, EU MTFs/OTFs share trebling from 1% to 3% in Jan 2021 and SEFs moving from 40% to 47% the USD swaps market has been remarkably consistent ever since with UK MTFs/OTFs consistently around 6%, EU MTFs/OTFs consistently around 3% and SEFs printing between 46-48% each month throughout Q1 and Q2.
Q1 versus Q2: The SEFs’ Q2 share was flat at 47% the UK venues’ share was flat at 6% and the EU share was flat at 3%.
Given the stability of USD and GBP swaps, we will only drill into more detail on EUR swaps this time…
On-venue EUR Swaps
With the off-facility trades removed the on-venue split shows the same trends albeit to a slightly greater degree.
EUR Dealer-to-Dealer Swaps
There was a sudden drop in D2D EUR swaps on UK MTFs/OTFs from 14% in January, February and March to 9% in April, May and June 2021. This is matched by a shift on SEFs from 15% in January, February and March to 20% in April, 19% in May and 21% in June implying a further shift in EUR D2D swaps.
EUR Dealer-to-Client Swaps
There had been a sudden jump in D2C EUR swaps on SEFs in March 2021 from 10% in February to 19% in March, this was followed by 15% in April, 16% in May and 17% in June so the SEF share of client trades appear to have stabilised at a higher level than seen historically. The EU venues’ share has remained consistent at around 16%. The UK venues’ share rebounded from 6% in March to 11% in April before posting 7% in May and 8% in June 2021.
It is noteworthy that the SEFs’ share of the EUR D2C swap market is now higher than the EU venues’ share.
EUR Swaps subject to a trading obligation (DTO/MAT[ii])
There was a sudden drop in EUR swaps subject to DTO/MAT on UK MTFs/OTFs from 15.5% in Q1 to 10.5% in Q2. This is matched by a shift on SEFs from 18% in Q1 to 25% in Q2 showing a material further shift in EUR swaps subject to DTO/MAT. The EU venues’ share has remained consistent averaging 38% in both Q1 and Q2.
EUR Swaps not subject to a trading obligation (DTO/MAT)
There hasn’t been a material shift in non-DTO/MAT EUR swaps. The only item of note is that UK venue’s share rose to 8% in April before falling to 6% in May and June and SEFs’ share increased from 19% in March and April to 21% in May and 22% in June. However, when you look at Q1 versus Q2 UK and EU venues are flat with the SEFs 2.5% increase from 18.5% to 21% almost entirely coming from a reduction in off-facility.
EUR Cleared[ii] Swaps
Well over 90% of EUR swaps are cleared. There was a sudden drop in Cleared EUR swaps on UK MTFs/OTFs from 12% in Q1 to 10% in April, 9% in May and 8% in June 2021. Meanwhile SEFs’ share increased from 19% in Q1 to 23% in April and May, and 26% in June implying a further shift in EUR cleared swaps. The EU venues’ share has remained fairly consistent. The rest of the SEFs’ increase came from a reduction in off-facility.
Conclusion
EUR Swaps: There was a further drift from UK venues to US venues in EUR swaps, while EU venue share remained flat. This could be due to clients being concerned about the longevity of the FCA relief making the changes needed to use a SEF.
GBP Swaps: There was a small decline in EU venues’ share of GBP swaps which is now half its December 2020 level, while UK venues are seeing a small increase posting their highest monthly share in 2021 in June.
USD Swaps: The USD swaps market appears to have plateaued with UK MTFs/OTFs consistently around 6%, EU MTFs/OTFs consistently around 3% and SEFs printing between 46-48% each month throughout Q1 and Q2.
EUR Swap Breakdown
D2D EUR Swaps: Q2 saw the UK venues’ share fall a further 5% from 14% to 9% while the SEFs’ share increased from 15% to 20% while the EU venues’ share has remained fairly consistent.
D2C EUR Swaps: The SEFs’ market share in Q2 was higher than the EU venues’ share for the first time.
EUR DTO/MAT Swaps: Q2 saw the UK venues’ share fall 5% from 15.5% in Q1 to 10.5% in Q2, while the SEFs’ share increased from 18% in Q1 to 25% in Q2 while the EU venues’ share has remained fairly consistent averaging 38% in both Q1 and Q2. Thus, the data shows a material further shift in EUR swaps subject to DTO/MAT from UK venues to SEFs.
EUR Non-DTO/MAT Swaps: Q2 saw the SEFs’ share increase 2.5% from 18.5% in Q1 to 21% in Q2, which almost entirely came from a reduction in off-facility swaps.
EUR Cleared Swaps: Q2 saw the SEFs’ share increase 5% from 19% in Q1 to 21% in Q2, which came equally from a reduction in UK venues’ share and off-facility swaps.
As mentioned previously, market share is one aspect of this story, market access is the other…
Some EU and UK banks and EU and UK clients have reduced market access
EU banks which do not have UK subsidiaries can no longer access 10% (Q2 average) of the EUR DTO IRS market that occurs on UK MTFs / OTFs.
UK banks which do not have EU subsidiaries can no longer access 38% (Q2 average) of the EUR DTO IRS market that occurs on EU MTFs / OTFs, except where trading with, or on behalf of, EU clients subject to the EU DTO which do not have access to a SEF.
Clients in the UK and EU have reduced choice about where to execute trades as, where the transactions are subject to an EU/UK DTO, clients in the UK are unable to trade on EU venues and clients in the EU are unable to trade on UK venues for DTO products.
Increased market fragmentation does not appear to have had a direct impact on liquidity
OTC derivative markets are global in nature and very agile. Trading liquidity in OTC IRS 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.
These shifts in market share have created a more geographically fragmented market in EUR and GBP IRS and a more geographically concentrated market in USD IRS on SEFs. OSTTRA has not performed a liquidity analysis. However, anecdotally the geographical fragmentation does not appear to have had a direct impact on liquidity.
January 2021 saw generally reduced EUR swap activity, both in terms of volumes and notional traded compared to January 2020. This could be explained by low volatility, caused by a low and stable interest rate environment. However, volumes rebounded in February and to an even greater extent in March. This rebound was primarily driven by inflation fears in the US. Volume in April was sharply down with May and June improving but still below January 2021 levels.
There has been little or no change in where OTC IRS are cleared
Based on our June 2021 data, over 93% of EUR and GBP IRS and 96% of USD IRS are cleared. Where OTC IRS clear and where they trade are independent decisions. Looking at the first half of 2021, UK CCPs clear over 99.5% of the GBP IRS market, over 96% of the USD IRS market, and 91% of the EUR IRS market. There has been no material change in this position for the GBP IRS market, while for the EUR and USD IRS markets, comparing H1 2021 with Q3 2020, there has been only minor variation and nothing to suggest any significant trends are emerging yet. This is something we will look into further in another piece shortly.
[i] 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 our MarkitWire platform.
[ii] 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).
[iii] 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.
Endnotes
- There is a small quantity of US MTF/OTF trades, these are immaterial and have been ignored for this analysis.
- 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).