Notional amount is not a good measure of the size of the interest rate swap (IRS) market, that is, of the magnitude of risk transfer through IRS. First, since a significant volume of IRS swaps are short term, notional amount exaggerates the extent of risk transfer in this market. Second, since trading conventions leave pairs of counterparties holding risk-offsetting long and short positions, notional amount—which adds longs and shorts—significantly overstates risk transfer between pairs of counterparties.
This paper introduces Entity-Netted Notionals (ENNs) as a better measure of market size. ENNs for a market are computed as follows: convert the long and short notional amounts of each entity to 5- year risk equivalents; net longs against shorts in a given currency within pairs of legal entities; and sum the resulting net longs (or net shorts) across entities. While any individual entity can easily calculate its own ENNs, the CFTC is uniquely positioned to calculate market ENNs using the detailed data it receives from Swap Data Repositories (SDRs).
To describe ENNs intuitively, imagine that each pair of swap counterparties established its net interest rate risk position with bonds instead of swaps. More precisely, within each pair of counterparties, the counterparty that is net long has purchased a 5-year equivalent risk position in bonds from the counterparty that is net short. Then, the sum of those hypothetical bond positions across all pairs of counterparties is a measure of the size of the market and is equal to ENNs as defined in this paper.
For all U.S. reporting entities as of December 15, 2017, notional amount across the dominant IRS products, namely, fixed-for-floating swaps, FRAs, OIS, and swaptions, is $179 trillion. Expressed in 5-year risk equivalents, that notional amount falls to $109 trillion. ENNs, however, are only $15 trillion, or just over 8% of notional amount. Therefore, measured with ENNs, the size of the interest rate swap market is comparable to the sizes of other fixed income markets, like corporate bonds at $12 trillion, mortgages at $15 trillion, or U.S. Treasuries at $16 trillion.
In conclusion, the great empirical difference between notional amount and ENNs in the IRS market argues strongly for moving away from notional amount as a metric of market size and risk transfer.