The Office of the Chief Economist produces original research papers on a broad range of topics relevant to the CFTC’s mandate to foster open, transparent, competitive, and financially sound markets in U.S. futures, option on futures, and U.S. swaps markets. In this role, the papers are written, in part, to inform the public on derivatives market issues and can be freely accessed below. They are commonly presented at academic conferences, universities, government agencies, and other research settings. The papers help inform the agency’s policy and regulatory work, and many are published in peer-review journals and other scholarly outlets.
The analyses and conclusions expressed in the papers are those of the authors and do not reflect the views of other members of the Office of Chief Economist, other Commission staff or the Commission itself.
This report, planned to be released quarterly, provides a high-level overview of trade activity and holdings for SOFR-based derivatives. This report parallels a number of other efforts that provide a quantitative view on the Libor transition.
Activity in SOFR-based futures and swaps has generally been increasing quarter-on-quarter. In some cases, like swaps, this growth can be significant (on the order of hundreds of percent).
Though the activity is spread across a number of different participant types, the level of activity is still significantly lower than the equivalent Libor-based markets. As one example, current open interest in Libor-based swaps stands at almost $100tn; this level is far higher than the just over $100bn in SOFR open interest.
In 2018, the CFTC introduced entity-netted notionals (ENNs) as a measure of risk transfer in interest rate swaps markets. In this paper, we extend the ENNs concept, for the first time, to futures markets, specifically interest rate futures.
Because futures markets are fully cleared markets, much less position netting is required in the ENNs calculation than in the equivalent interest rate swaps market. However, given that the duration of interest rate futures contracts is generally lower than that for swaps (e.g. the very short duration Eurodollar futures contract), there is a much larger difference between the notional and the duration-adjusted notional of futures markets relative to swaps.
In aggregate, the total notional size of major interest rate futures positions as of the end of June 2019 is roughly $81tn (compared to $248tn in swaps). This reduces to $1.6tn in futures ENNs equivalents, significantly lower than the size of rate swaps as measured by ENNs - $14.5tn.
Richard Haynes, John Roberts, Rajiv Sharma, Bruce Tuckman
The paper argues that notional amount, a commonly used measure of the size of derivatives markets, does not accurately represent the amount of risk transfer in interest rate swap markets. The paper then introduces a novel metric, Entity-Netted Notionals (ENNs), as a superior measure of market size.
ENNs are the sum of all net long (or short) swaps exposures, expressed in 5-year equivalents, where netting is calculated within each counterparty pair and currency.
As measured by ENNs, the U.S. regulated Interest Rate Swaps market is approximately $17 trillion in size, significantly lower than the notional amount of $224 trillion. This $17 trillion exposure is comparable in size to many other fixed income markets, like corporate bonds at $12 trillion or U.S. Treasuries at $16 trillion.
Lee Baker, Richard Haynes, Madison Lau, John Roberts, Rajiv Sharma, Bruce Tuckman
This white paper makes use of CDS and FX swap position data to calculate entity-netted notional (ENNs) equivalents for the two new asset classes. The report, like the earlier one on IRS positions, translates swap notional values into risk-based measures more easily comparable to other financial markets like corporate bonds.
After risk-adjusting CDS markets against a 5-year CDS benchmark contract and allowing for counterparty netting, the $5.5tn notional market falls to a $2.0tn risk-adjusted equivalent. After a similar netting exercise in FX markets, the authors calculate a reduction from $57tn of swap notional to a significantly lower $17tn ENNs level.
Using these risk-adjustments, the size of all three markets (IRS, FX, and CDS) falls to levels comparable to that of markets like corporate bonds ($13tn) and U.S. Treasuries ($17tn).
John Coughlan, Richard Haynes, Madison Lau, Bruce Tuckman
The paper uses regulatory data collected on open uncleared swap positions in CDS, FX and IRS markets to identify and analyze swaps that hold legacy status under the CFTC’s uncleared margin and clearing rules.
The findings show a small but non-negligible amount of legacy swap notional outstanding under the uncleared margin rule, with a large percentage projected to fall into scope when phase 5 of the rule occurs. In contrast, total swap notional representing legacy swaps under the clearing requirement is quite low, often only a few percentage points of the notional for each asset class.
Of the IRS legacy swaps under the uncleared margin rule, over 70% may require amendments to address the planned cessation of LIBOR and other interbank offered rates, a transition which is currently underway.
There is a market core. Of the almost 4,000 reported grain and oilseed futures traders in 2015-2018, the top 25% most persistent traders account for around 80% of the open interest. Just under 200 persistent traders make up 40% of the open interest.
Granularity matters. Of nine trader categories, just three (managed money traders and commercial dealers/merchants, plus commodity index traders on the long side) account for about four fifths of all large trader positions. Managed money (non-commercial) and dealer/merchant (commercial) positions are strongly negatively correlated.
Traders overwhelmingly hold positions in contracts maturing in less than a year. The short-term focus is especially strong for non-commercial traders.
Calendar spreads account for one third of the reported open interest. Commercial traders who are not swap dealers (commercial dealers/merchants, mostly) make up from a quarter to two fifths of all calendar spread positions. Much of the intra-year variation in the total futures open interest can be tied to changes in calendar spreading.
Market participants argue that the recent leverage ratio has become the binding constraint for certain, often low-risk derivatives businesses, such as client clearing.
We examine the potential effect of the Basel III leverage ratio on cleared equity futures options, products where the leverage ratio demands particularly high capital relative to risk.
We find that the clearing of equity options has shifted from firms subject to higher leverage requirements (e.g., US GSIB banks) to those subject to a lower requirement (e.g., banking affiliate of EU firms and non-banks).
We find that the shift in market shares is most evident in low-delta options, which have relatively small risk for a given notional amount, and is absent in US Treasury futures options, which are subject to a lower requirement.
We measure how quickly market participants enter an order into the limit order book after their existing order was executed or cancelled
We find that traders take longer to place a new market order compared to a new limit order
We also find that market participants are quicker to place a new order if there are more executions taking place in the market, if there are more new orders being placed on the limit order book; but market participants are slower to place a new order if there are more cancellations happening on the limit order book.
The paper analyzes the prevalence of automation across futures markets, tracking changes over the period from 2012 through 2018.
Automation use is highest for financially based instruments like FX futures, the S&P E-mini and U.S. Treasury contracts. Automation levels are commonly lower, though increasing, for physical commodities like grains, softs and livestock.
Though most markets have gotten faster over time, with order resting times and execution times decreasing across the six year period, the rate of change appears to have flattened in recent years.