We use proprietary transaction data on interest rate swaps to assess the effects of centralized trading, as mandated by Dodd–Frank, on market quality. Contracts with the most extensive centralized trading see liquidity metrics improve by between 12% and 19% relative to those of a control group. This is driven by a clear increase in competition between dealers, particularly in U.S. markets. Additionally, centralized trading has caused interdealer trading in EUR swap markets to migrate from the United States to Europe. This is consistent with swap dealers attempting to avoid being captured by the trade mandate in order to maintain market power.

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Citation: Benos, E., Payne, R. & Vasios, M. (2016). Centralized trading, transparency and interest rate swap market liquidity: evidence from the implementation of the Dodd-Frank Act. UK: Bank of England, ISSN 1749-9135. This is the published version of the paper.This version of the publication may differ from the final published version. Permanent repository link AbstractWe use proprietary transaction data on interest rate swaps to assess the impact of centralized trading, as mandated by Dodd-Frank, on market quality. We show that it has led to activity increasing and liquidity improving, with the largest improvements for contracts most affected by the mandate. Associated reductions in execution costs are economically significant eg daily end-user costs of trading USD relative to EUR mandated contracts drop by $3 million-$4 million. We show that requiring centralized trading in the United States caused swap markets to fragment geographically and give evidence which suggests that fragmentation is due to dealers trying to maintain market power.Key words: Swap Execution Facilities, transparency, liquidity.JEL classification: G10, G12, G14.( IntroductionThis paper is a study of how recent regulatory changes to Over-the-Counter (OTC) derivative markets have altered the quality of those markets. In particular, we examine how implementation of the centralized trading mandate of the Dodd-Frank act has impacted liquidity and trading patterns in interest rate swap (hereafter 'swap') markets, the world's largest OTC derivative market (BIS (2014)).Prior to the implementation of Dodd-Frank, swap trading was largely decentralized and opaque. There was no central source for trade information and no liquidity hub that published pre-trade information on quotes and sizes. Therefore, buyers and sellers bore pecuniary and time costs when searching for quotes and counterparties (see Duffie et al. (2005) and Duffie (2012)). The opaque nature of the market and imperfect competition among swap dealers may also have allowed the largest swap dealers to exploit other traders (see Kyle (1985) and Vayanos and Wang (2012)

We analyse the effects of EMIR and Basel III regulations on short-term interest rates. EMIR requires central clearing houses (CCP) to continually acquire safe assets, thus expanding the lending supply of repurchase agreements (repo). Basel III, in contrast, disincentivises the borrowing demand by tightening banks' balance sheet constraints. Using unique datasets of repo transactions and CCP activity, we find compelling evidence for both supply and demand channels. The overall effects are decreasing short-term rates and increasing market imbalances in various forms, all of which entail unintended consequences originated from the new regulatory framework.