Most big trades between the world’s largest banks and customers in the $442 trillion interest-rate swap market are hedged within 30 minutes of the transaction, according to the Federal Reserve Bank of New York.
Researchers at the Fed analyzed three months of interest- rate derivative market information for a study released today on how public price reporting may affect trading in the instruments. The report found that the 14 largest banks offset their trades within half an hour about 60 percent of the time. That contrasts with hedging in the credit-default swap market, because banks can hedge risk in rates more easily, the report said. Delays in reporting large trades are being debated by U.S. regulators to offer time for banks to offset the risk they take.
The finding “appears to highlight a significant contrast to the credit-default swap market, where earlier published analysis found little evidence of large customer trades being offset through subsequent trading on the same or next day,” the central bank study said. “Our findings suggest that introducing a public price reporting regime may not disrupt hedging activity in interest-rate swaps as long as there are meaningful protections that delay reporting or mask trade sizes.”
The Commodity Futures Trading Commission and Securities and Exchange Commission are leading efforts to write rules mandated by the Dodd-Frank Act to reduce risk and boost transparency in trades by firms including Deutsche Bank AG, Barclays Plc (BARC) and Cargill Inc. Dodd-Frank was enacted by President Barack Obama in July 2010 after trades in the unregulated swaps market helped fuel the 2008 credit crisis.
The world’s biggest 14 banks didn’t offset large corporate or sovereign CDS trades with customers on the same day 45 percent of the time, a similar study by the New York Fed found in September. Banks didn’t hedge large trades the day after in 67 percent of cases, the study said.
Banks say they need extra time before large trades are reported to enter into offsetting transactions to reduce their exposure and to prevent competitors from profiting by trading ahead of the hedging.
The CFTC has yet to define what makes up a large trade in the swaps market. Until that definition is created, all swaps reporting is subject to a delay of at least 30 minutes, according to the final rule passed by the agency in December. End users such as corporations will get a 48-hour delay, the CFTC said.
Nine Time Periods
The central bank suggested using the period of time covered by an interest-rate swap, known as the tenor, as a way to determine what trades should trigger the delay. The notional size of trades in rate swaps decreases as the trades lengthen in time, the study found.
It recommended dividing the market into nine categories based on the tenor, such as swaps written to last for one to three months, or one to two years. Amounts within those time periods could then be established to get protection from the time delay. The report also said the rules should distinguish between contracts denominated in U.S. dollars, euros, Japanese yen and British pounds, and all other currencies.
The CFTC has put out a proposal for industry comment that would separate the interest-rate swap market into eight tenors for determining large trade size. The CFTC used the same data that the New York Fed analyzed in the rate swap market. Comments on the CFTC proposal are due by May 14.
The data was gathered from actual trades in the interest- rate derivative market from June to August 2010. It found about 300 users of the instruments, which is dominated by the world’s 14 largest banks. Average trade size was $270 million with about $683 billion in notional value traded daily. Trading in interest-rate swaps was infrequent, with no rate swap changing hands more than 150 times a day on average, the study said.
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