European Central Bank publishes duration-based method to measure synthetic leverage in interest rate swaps

The European Central Bank has published research in its Macroprudential Bulletin proposing a new framework for measuring synthetic leverage in interest rate swaps, aimed at improving risk identification for non-bank financial intermediation. The article argues that common notional-based metrics can misstate market exposure and resilience to interest rate shocks, and introduces a duration-sensitive approach designed for scenario analysis and for linking derivatives-driven leverage to liquidity and solvency risks. The methodology applies a replica-portfolio approach that maps an interest rate swap position into cash-equivalent balance sheet items, defining “static” synthetic leverage using the present value of a synthetic fixed-rate bond as the exposure measure and posted initial margin plus net received variation margin as committed resources. It then derives a “dynamic” synthetic leverage measure that uses modified duration to estimate how leverage evolves under a given rate shock. The authors test the framework using European Market Infrastructure Regulation trade repository data for euro area non-bank entities (investment funds, insurance companies and pension funds), focusing on euro-denominated fixed-for-floating swaps at month-end points from January to December 2022, and illustrate that the same interest rate move can generate materially different leverage paths depending on swap duration, including under a 130 basis point stress calibrated to an LDI-like shock.