The over-the-counter interest rate derivatives market grew by more than US$60trn last year, according to a report published by the International Swaps and Derivatives Association.
Combined OTC interest rate derivatives notional traded across the UK, US and European Union reached US$521.5trn in 2023 according to ISDA’s analysis of data publicly reported by European trading venues and the US Depository Trust and Clearing Corp – a 13.1% increase from US$461.2trn traded in 2022.
Of this activity, 43.4% stemmed from euro-denominated trades while 32.3% and 10.8% came from US dollar and sterling trades, respectively. Other currencies accounted for 13.5% of activity, with the Australian dollar, Canadian dollar and yen representing the largest shares.
Tightened central bank monetary policy was the main driver of increased activity, say derivatives experts, as cumulative rate hikes across the major economies saw market participants facing the highest interest rates in more than a decade – fuelling greater client demand for derivatives as a means of hedging their growing exposures.
"The large moves in interest rates that we've seen over the last 18 months have triggered a lot of duration management flows as well as speculative flows," said Tom Prickett, head of EMEA rates trading at JP Morgan. "When rates move by the magnitude that we've seen, that triggers an increase in derivatives activity", which corroborates ISDA's findings, he said.
Specific market events, such as the collapses of Credit Suisse and Silicon Valley Bank in the first quarter of 2023, were also major drivers of interest rate derivatives activity, said experts.
Such events, combined with central bank policy decisions “contributed to record risk transfer by global participants with interest rate exposure", said Agha Mirza, global head of rates and OTC products at CME Group, whose OTC clearing business saw a 24% increase in cleared interest rate derivatives notional volume in 2023.
Euro strength
Growth in interest rate derivatives activity was most pronounced in euro-denominated trades, said ISDA, with traded notional increasing by 24.4% to US$226.2trn. In comparison, sterling-denominated trading activity grew by 8.5% to US$56.5trn in traded notional while US dollar-denominated activity fell 1.9% to US$168.4trn.
Derivatives experts point to the European Central Bank playing catch-up with its peers over monetary policy decisions as the main reason for the comparative growth in euro-denominated trades compared with US dollars and sterling.
For instance, while the US Federal Reserve started hiking interest rates in March 2022 to tackle inflation, it took another four months for the European Central Bank to follow suit, and the Fed’s tightening cycle ended in July last year while the ECB’s continued until October. This discrepancy in timelines ultimately fuelled greater sustained demand for euro-denominated derivatives among market participants looking to hedge their rates exposures.
Stronger year-on-year growth in euros versus US dollars "is what we witnessed [last year]", said Phil Whitehurst, head of service development, rates at LCH SwapClear – which saw a 21% increase in OTC interest rate derivatives notional across currencies in 2023.
LCH is part of LSEG, which also owns IFR.
Nevertheless, institutions like Natixis CIB saw strong growth for US dollar-denominated OTC interest rate derivatives among its client base. While the bank saw a 71% increase in overall interest rate derivatives traded notional in 2023, its US dollar-denominated volumes doubled between 2022 and 2023, and euro-denominated volumes grew by 40%.
"As a European bank ... our USD volumes are still below our EUR ones, though," said Pascal Amiel, co-head of rates and currencies markets at Natixis.
Sustained growth
Interest rate derivatives activity remains strong this year, primarily fuelled by ongoing uncertainty as to when – and by how much – central banks across major currencies will start cutting interest rates.
Natixis’ volume for the first quarter was three times larger than in 2023 – an “outstanding start of the year”, said Amiel. Risk management activity among JP Morgan's clients has been "consistent" coming into 2024, said Prickett. "That itself likely means that interest rate derivatives volumes will remain high," he said. LCH said the first quarter showed strong year-on-year OTC growth.
Activity within the listed derivatives market is also off to a strong start. Year-to-date average daily volume for CME’s interest rate futures and options business has increased 11% compared with 2023, with 13.8m contracts, said Mirza.
Corrected story: Clarifies 11th and 16th paragraphs