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

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.