Bank of England Staff Find That SEFs Reduce Swap Trading Costs

A Bank of England Staff Working Paper titled "Centralized Trading, Transparency and Interest Rate Swap Market Liquidity: Evidence from the Implementation of the Dodd-Frank Act" found that the overall "improvements in transparency brought about by the Dodd-Frank trading mandate have substantially improved interest rate swap market liquidity." The authors argued that transparency has reduced trading costs, despite a decrease in cross-border trading as European counterparties refrain from doing business with U.S. persons in order to avoid becoming subject to U.S. regulation.

The authors found that the introduction of swap execution facility ("SEF") trading resulted in substantially reduced execution costs, particularly for U.S. Dollar-denominated swaps that are subject to mandatory clearing. The authors estimated that this reduction came to as much as $20-$40 million daily. The authors attributed this decline in part to the shrinking of "intermediation chains" and the follow-on reduction in dealer markups. The authors noted that the "asymmetric implementation" of the trading mandate resulted in geographic market fragmentation, and that, in the Euro-denominated segment of the market, some non-U.S. firms avoided transacting with U.S. firms. The authors concluded by suggesting that "extending the scope of the trading mandate to cover other sufficiently liquid swap markets would be desirable."