Aninterest rate swap is aderivative contract in which two parties exchange streams of interest payments on anotional principal for a set period. The most common form exchanges a fixed rate for a floating rate in the same currency. Variants includebasis swaps,overnight index swaps (OIS), forward-start swaps and swaps with changing notionals. Since the late 2000s, collateralised swaps are typically priced and risk-managed using OIS discounting, and following the end ofLIBOR new trades reference overnight risk-free rates such as theSOFR, theSONIA and the€STR. As at end-June 2024, interest rate derivatives were the largest segment of the global over-the-counter derivatives market by notional outstanding.[1][2][3]
Arrangements resembling swaps emerged from back-to-back or parallel loans used in the 1970s to navigate exchange controls. A widely cited early landmark was a 1981 currency swap between IBM and the World Bank arranged by Salomon Brothers, which helped popularise the technique.[4][5] The first interest rate swap is commonly dated to 1982.[6]
Standard documentation and definitions from theISDA in the 1990s and 2000s supported market growth and common terminology.[7] After the2007–2008 financial crisis, pricing for collateralised swaps shifted toOIS discounting and multi-curve approaches, reflecting the role of collateral and funding costs.[8]
From 2021 to 2024, regulators completed the transition fromLIBOR to overnight risk-free rates. Remaining synthetic sterling and United States dollar LIBOR settings ceased in 2024, which marked the end of LIBOR in mainstream use.[9][10]
A standard interest rate swap has two legs linked to the same notional amount. The fixed leg pays a fixed rate on scheduled accrual periods. The floating leg pays a rate set at each reset date by a reference index such as theSOFR, theSONIA or the€STR, with payments exchanged on the corresponding payment dates. Day-count and business-day conventions follow market standards defined in documentation such as theISDA Interest Rate Derivatives Definitions and, for on-venue trading, the relevant rulebooks.[11][12]
Variants include forward-start swaps, amortising or accreting notionals, zero-coupon swaps,basis swaps in which both legs float, andovernight index swaps that reference a compounded overnight rate.
Common structures include the following.[13][14]
Common uses include hedging interest rate exposure, adjusting asset and liability duration, and expressing views on the level or shape of theyield curve. In United States markets, the futures and swaps ecosystem now linksSOFR futures and SOFR-linked swaps after the conversion ofEurodollar futures and USD LIBOR swaps in 2023.[15]
A vanilla fixed-for-floating swap has a value equal to the difference between the present value of the fixed leg and the present value of the floating leg, discounted on the appropriate curve.
The present value of the fixed leg is
where is notional, is the fixed rate, are accrual fractions, are payment dates and are discount factors.
Under a standard par-swap set-up, the floating leg can be written using forward rates and discount factors:
The par swap rate that sets the swap’s value to zero is
For a quoted swap with fixed rate, the mark-to-market is often written
with.
Following the financial crisis, collateralised swaps are commonly discounted using theovernight index swap curve that matches the collateral rate specified under thecredit support annex. This leads to multi-curve frameworks that separate discounting from forward-rate projection.[16][17]
A large share of plain-vanilla swaps iscentrally cleared, with clearing mandates and reporting rules in major jurisdictions. In the United States, theCommodity Futures Trading Commission updated the clearing requirement in 2022 to reflect the transition to risk-free rates and addedSOFR overnight index swaps across standard maturities.[18] In the European Union, reforms under theEMIR 3.0 framework introduce an active account requirement intended to ensure EU market participants maintain and use accounts at EU central counterparties for specified interest rate derivatives.[19]
Market convention summaries for on-venue trading are published byswap execution facilities and multilateral trading facilities.[20]
Typical fixed-leg conventions for vanilla swaps vary by currency. Actual terms depend on documentation and venue rules.[21][22]
| Currency | Typical fixed-leg frequency | Typical fixed-leg day count | Common floating index |
|---|---|---|---|
| USD | Semi-annual | 30/360 | SOFR (compounded) |
| EUR | Annual | 30/360 | €STR (compounded) orEuribor (legacy) |
| GBP | Semi-annual | ACT/365F | SONIA (compounded) |
| JPY | Annual | ACT/365F | TONA (compounded) |
Interest rate swaps expose users to several categories offinancial risk. The main market risk isinterest rate risk, since changes in discount factors and forward rates alter present value and can turn a position from an asset into a liability.Basis risk can arise when cash flows reference different floating rates or tenors, including in the post-LIBOR environment where differences between risk-free rates can be material.[23][24]
Swaps also createcounterparty credit risk. Banks measure and manage the possibility that a counterparty may default, as well as changes in the value of expected exposures. Under the Basel framework, acredit valuation adjustment capital charge applies to capture the risk of CVA changing with credit spreads.[25][26]
Collateral and margining mitigate bilateral credit exposure but introduce funding and liquidity risks. Requirements atcentral counterparties and in bilateral agreements can amplify margin calls during stress. Central clearing reduces bilateral counterparty and liquidity risk through multilateral netting, but concentrates exposures between clearing members and the CCP.[27][28][29]
Financial reporting for swaps reflects these risks. UnderIFRS 9, hedge accounting requirements replacedIAS 39 and align reporting more closely with risk management. UnderUS GAAP,ASC 815 governs derivatives and hedging, including targeted improvements issued since 2017.[30][31][32]
ICE Swap Rate, formerly ISDAFIX, is a benchmark for swap rates in major currencies and is used in the valuation of some interest rate swaps andswaptions and for certain close-out calculations.[33]
General:
Early literature on the incoherence of the one curve pricing approach:
Multi-curves framework:
and are regarded as an
