Examining the impact of central clearing and swap execution facilities on interest rate swap spreads and their determinants

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Abstract

This study explores how the determinants of interest rate swap spreads have changed since the implementation of Title VII of the Dodd-Frank Act of 2010. Utilizing ordinary least squares (OLS) regression, we analyze key variable effects at different stages of the regulation. Through this approach, we offer valuable insights into the impact of central clearing and trading on swap execution facilities (SEFs) and swap spreads. First, contrary to previous empirical evidence, increases in swap volatility correspond to a tightening, rather than a widening, of swap spreads after the implementation of SEF trading. This result suggests the SEF framework may enhance the appeal of swaps as a safe-haven and hedging instrument. Second, we observe that the Treasury liquidity premium (TLP) no longer significantly influences swap spreads after the implementation of SEF trading. Third, after SEF trading occurs, the curve slope and swap volatility remain the only significant drivers of swap spreads. Last, a difference-in-difference analysis reveals that the regulation did not materially impact changes in swap spreads; instead, they align with the observed trend of spread tightening in the overall markets. These results signify significant departures from previous research findings (Grinblatt, 2001; Fehle, 2003; Tah, 2022), holding importance for academic scholars and practitioners in swap pricing and risk management.

Keywords: Swap Spreads, Interest Rate Swap, Treasury Liquidity Premium, Hedging, Dodd-Frank, Title VII

Authors’ individual contribution: The Author is responsible for all the contributions to the paper according to CRediT (Contributor Roles Taxonomy) standards.

Declaration of conflicting interests: The Author declares that there is no conflict of interest.

JEL Classification: G12, G14, G18

Received: 14.11.2023
Accepted: 12.01.2024
Published online: 15.01.2024

How to cite this paper: McAlley, E. (2024). Examining the impact of central clearing and swap execution facilities on interest rate swap spreads and their determinants. Risk Governance and Control: Financial Markets & Institutions, 14(1), 8–18. https://doi.org/10.22495/rgcv14i1p1