Introduction To Total Return Swaps - Tavakoli Structured Finance

Total Return Swaps (TRS): Benefits, Risks, and Applications

By Janet Tavakoli, President of Tavakoli Structured Finance and Author of Credit Derivatives and Securitization. Updated June 2025.

What is a Total Return Swap?

A total return swap (TRS) is a financial contract between a total return payer (asset owner) and a total return receiver (investor). The payer transfers the asset’s total return—interest and price changes—to the receiver, who pays a floating rate (typically SOFR plus a spread). At maturity, the receiver pays any price decline or receives appreciation. Reference assets include bonds, loans, equities, or indices.

A TRS is a type of credit derivative and a synthetic financing.

Total Return Swap Structure: Payers vs Receivers

Counterparties in a TRS:

• The total return payer: The legal owner of the reference asset who pays the total return of that asset.
• The total return receiver: The investor who receives the total return while paying a financing cost (typically SOFR plus a spread).

If the price of the reference asset has declined at the end of the TRS, the investor, the receiver of the total return, must pay the difference between the original price and the termination price to the TRS payer. The price decline may be due to market risk, credit risk, or both. Market risk includes a price decline due to a decline in interest rates, a credit spread widening, or both. Credit risk includes any predefined impairment of the asset, such as a credit default or a missed interest payment.

If there is no change in price, the investor does not make a payment.

If the security appreciates, the investor gets the difference between the original price and the new, higher price.

The investor (receiver) makes ongoing payments to the total return payer for all this. In the credit derivatives market, this payment is referred to as the floating rate payment, the financing cost, or the investor’s funding cost.

The reference assets in total return swaps can include indices, bonds (emerging market, sovereign, bank debt, mortgage-backed securities, tranches of collateralized debt obligations, corporate), loans, equities, real estate receivables, lease receivables, or commodities.

How Total Return Swaps Work: A Practical Example

Imagine leasing a Tesla with a full-service package. As the total return receiver, you enjoy all benefits—driving, and maintenance covered—without owning the car. At the end of the lease, you pay any depreciation or receive appreciation.

Similarly, in a total return swap, the investor (the receiver):

• Receives an asset’s cash flows without ownership.
• Pays any price decline or gains appreciation at maturity.
• Makes ongoing floating rate payments (e.g., SOFR + spread). Reference assets range from corporate bonds to commodities.

Total Return Swap Structure Elements

• Total Return = Interest Flows + (Final Value – Original Value)
• Total Return Payer = Legal owner of the Reference Asset(s)
• Total Return Receiver = Long both price and default risk of Reference Asset(s)
• Funding Risk = Exposure to positive or negative changes in floating rate funding cost

Off-Balance Sheet Aspects of Total Return Swaps

Total return swaps are off-balance sheet transactions that enable synthetic asset creation without ownership. Banks with low funding costs often act as payers, while hedge funds seeking leverage are receivers. This opaque over-the-counter market hides leverage, as seen in MF Global’s 2011 collapse, where “repo-to-maturity” trades mimicked TRS. The label was form over substance sleight of hand to avoid calling the transaction a total return swap (see below).

Total Return Swap Applications in Banking and Investment

Total Return Swaps vs. Other Credit Derivatives

Total return swaps are part of an opaque over-the-counter market introducing hidden leverage into the financial system. Global regulators are blind to the volume of total return swaps and other credit derivatives embedded in structured financial products such as credit-linked notes. The total return swap differs from a credit default swap in that the asset is usually a physical asset, not a notional amount referencing a physical asset..

Total return swaps establish specific risk positions:

• The total return payer is the legal owner of the reference asset and holds it on its balance sheet. For the transaction period, the TRS payer has a short position in market risk and a short position in the reference asset’s credit risk. It also has potential interest rate risk if rates decline.
• The total return receiver, the investor, is not the legal owner of the reference asset. The TRS is an off-balance sheet transaction. The reference asset does not appear on the receiver’s balance sheet. For the transaction period only, the total return receiver has a synthetic long position in the asset and bears the market and credit risks. The TRS receiver also has the risk that the funding cost reference rate may increase, thus increasing the funding cost.
• At maturity, the total return receiver may purchase the reference asset at the prevailing market price but is not obligated to do so.

Total Return Swaps and Default Scenarios

The TRS usually terminates if the reference asset defaults before the maturity date of the TRS. However, there are exceptions beyond the scope of this article. In either case, the total rate of return receiver bears the risk of default.

If the TRS terminates due to a default, the total rate of return receiver, the investor, makes the total rate of return payer “whole” for the market risk and the credit risk of the reference asset through either:

1. A net payment of the difference between initial price and default price, or
2. Taking delivery of the defaulted asset and paying the initial price

Once this occurs, neither party has any additional obligations, and the TRS terminates.

Total Return Swap Counterparties: Motivations & Risks

Motivation of the Total Return Swap Receiver

TRS receivers are motivated by financing and leverage. Investors hoping to boost their returns engage in financing, accept higher risk, and hope to achieve leveraged returns.

There are many reasons for a payer and a receiver (investor) to enter into a total return swap. However, one compelling reason exists for the investor (receiver) in the total return swap. Many credit derivatives specialists who either miss the point or pander to the sensitivities of credit managers and regulators will cite reasons such as the following. They state that investors, the TRS receivers can achieve one or more of the following benefits:

• Create new assets with a specific maturity not currently available in the market.
• Gain efficient off-balance sheet exposure to a desired asset class, such as syndicated loans or high-yield bonds, to which they otherwise would not have access.
• Achieve a higher return on capital. Total return swaps are often treated as derivatives or off-balance sheet instruments, while direct asset ownership is an on-balance sheet, funded investment.
• Diversify by filling in the credit gaps in their portfolios.
• Reduce administrative costs via an off-balance sheet purchase (as opposed to buying loans on the balance sheet).
• Access entire asset classes by receiving the total return on an index.

These are all reasonable points. However, the key reason is that investors (receivers) can take advantage of leverage.

The key reason receivers of the total return enter into this transaction is to take advantage of leverage.

Investors, total return receivers, make no initial cash payment. Cash flows are usually paid on a net basis. The investor’s “payments” are subtracted in advance from the security’s cash flow. The investor does nothing yet receives a positive net payment if the investor’s funding cost remains less than the security’s cash flows. If the investor receives a fixed coupon and makes a floating payment, it could happen that in an inverted-yield-curve environment, the investor would have to make a net payment.

Transparent Creditworthy TRS Receivers

If the TRS receiver is a creditworthy bank or another creditworthy counterparty, usually no upfront collateral is required. The receiver puts up no cash. The spread earned is pure spread income: the payment on the TRS minus the receiver’s funding cost.

TRS Risks: Counterparty, Leverage and Regulatory Concerns

Leverage is why hedge funds are a primary target as receiving counterparties in total return swaps. Their primary motive is to exploit leverage. The participation of hedge funds and other shaky, albeit partially collateralized, counterparties is a critical and not necessarily welcome development in the credit derivatives market.

Whereas the motive of the hedge fund counterparty is leverage, the motive of the payer of the total return in the TRS is high earnings. But what is the quality of these earnings? Are the “earnings” worth the risk?

Many hedge funds will take as much leverage as they can get. During the financial crisis, banks offloaded problematic assets by offering 10:1 leverage. Today, many behind-the-scenes deals can have enormous leverage.

Moreover, hedge funds are not the only type of questionable counterparty. As we will see later, MF Global was an overly leveraged brokerage firm, and Archegos was an overly leveraged family office. Both overly leveraged entities blew up.

Motivation of the Total Return Swap Payer

Financial institutions are often total return swap payers and use them for various applications: balance sheet management, portfolio management, covert risk transfer, rent-seeking, and asset swap maturity manipulation. The payer in a total return swap creates a hedge for the reference asset’s price and default risks while maintaining legal ownership.

Benefits of Total Return Swaps for Portfolio Management

This arrangement benefits TRS payers who:

• Cannot short securities but need to hedge long positions.
• Believe a reference asset may temporarily widen in spread but ultimately recover.
• Need flexible structures that do not require asset sales.
• Defer recognition of gains or losses.

How Hedge Funds Use Total Return Swaps for Leverage

When a bank transfers credit risk by paying the total return to a hedge fund, significant questions arise about risk reduction effectiveness. Credit managers face a dilemma: banks want to reduce risk cost-effectively, while credit derivatives traders seek hedge fund business due to higher financing costs than banks, insurance companies, or investment banks.

The higher funding costs demanded from hedge funds stem from their lack of balance sheet transparency. Credit managers evaluating hedge funds have limited information and cannot determine:

• How many similar transactions the fund has undertaken.
• The fund’s overall leverage.
• The adequacy of collateral (which can be as low as 5%).

Banks requiring 20% upfront collateral often lose business to competitors offering more favorable terms. While some banks require daily mark-to-market on underlying assets with “cure” periods for additional collateral, practices vary significantly.

This creates fundamental questions about the transaction value:

• Does the bank benefit from reduced joint probability of default?
• Is there a reduced probability?
• Does upfront collateral enhance the hedge fund’s credit quality sufficiently?
• Will collateral cover value decline if the underlying asset defaults?

Using hedge fund counterparties seems to pervert the concept of credit derivatives. Most banks would not view hedge funds as single A-rated, but the actual rating remains uncertain due to insufficient disclosure. Banks’ willingness to engage with hedge funds reflects the challenge of generating income from traditional investment-grade loan business, which typically shows low returns on capital.

The primary goal is not increased distribution but booking higher spread income. The question is whether enhanced spread income from hedge funds adequately compensates for credit risk.

In reality, hedge fund “guarantees” provide phantom protection, with the only tangible benefit coming from upfront collateral. With some hedge funds providing only 5% collateral, exposure reduction is minimal, and uncertainty remains about the fund’s ability to provide additional funds in default scenarios.

Total Return Swap Regulation: Who Oversees TRS Markets?

Regulators vary by venue and may vary within the same venue depending on the TRS and its application. . Here are some examples: In the U.S., the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) divide responsibilities depending on the TRS type and the underlying assets. The CFTC regulates TRS based on security indexes, commodities, and currencies. The SEC regulates security-based TRS, i.e., backed by a single loan, security, certain security indexes, ETFs, and custom baskets. The SEC also regulates Security-Based Swap dealers (SBSDs). The SEC and CFTC jointly regulate mixed swaps such as security-based swaps with interest-rate options or other non-securities components.

In Europe, the Securities Financing Transactions Regulator (SFTR) regulates total return swaps. In the UK, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) regulate them.

Regulators, regulations and products are subject to change, and one must stay abreast of new developments.

Total Return Swap Case Studies: MF Global and Archegos

MF Global’s Total Return Swap Collapse: Lessons Learned

The Catastrophic Collapse

MF Global’s 2011 bankruptcy represents one of the most significant collapses in the financial sector since the 2008 collapse of Lehman Brothers. Under CEO Jon Corzine’s direction, the derivatives and commodities brokerage firm engaged in highly leveraged triparty “repo-to-maturity” (RTM) trades that functionally mirrored total return swaps as illustrated below.

For an in depth look at this transaction, see Credit Derivatives and Securitization, 3rd Edition (2023) by Janet Tavakoli, President of Tavakoli Structured Finance.

Accounting Manipulation

These transactions allowed MF Global to keep $6.3+ billion in European sovereign debt exposure off its balance sheet through accounting sleight of hand. While labeled as “repo-to-maturity” trades, these arrangements shared nearly identical characteristics with total return swaps, differing only in technical end-date specifications.

Customer Funds Misappropriation

When these highly leveraged positions (reportedly 35:1 to 40:1) faced market volatility, MF Global could not meet margin calls. The firm impermissibly transferred nearly $1.6 billion from segregated customer accounts to satisfy these calls, violating fundamental regulatory requirements.

Serving on the House Banking Committee, Representative Marcy Kaptur read a Special Order on MF Global into the Congressional record: “[S]omeone took other people’s money. I believe most of us would call that theft.”

Risk Management Failure

This case highlights critical risk management principles: markets can remain volatile longer than undercapitalized firms can remain solvent. Despite Corzine’s belief that the underlying bonds would pay at maturity, MF Global lacked sufficient capital to weather interim volatility – a fundamental failure in leveraged finance.

Regulatory Consequences and a Real-World Lesson

After MF Global’s collapse, a New York Federal Court fined Jon Corzine $5 million for his part in the “unlawful use of customer funds.” The court also permanently banned him from registering with the Commodity Futures Trading Commission (CFTC) or working with any Futures Commission Merchant. Despite these penalties, Corzine—who previously served as Goldman Sachs Chairman and CEO, New Jersey Senator, and New Jersey Governor—paid the fine without apparent difficulty. Today, Jon Corzine runs JSC Opportunity Fund as founder, CEO, and Chief Investment Officer.

The penalty seems modest compared to the $1.6 billion misappropriation and the massive financial harm to thousands of customers, including many farmers who used futures to hedge the value of their crops. Why were there no criminal charges?

Corzine had been a significant Democratic donor and fundraiser. He hosted a private fundraiser for Obama at his Manhattan home and contributed the maximum individual amount of $35,800 to Obama and Democrats for the 2012 election. According to the Center for Responsive Politics, Corzine and his family donated more than $933,000 to Democratic candidates and groups since 1990.

After the MF Global scandal broke, the Obama campaign returned approximately $70,000 in contributions made by Corzine and his wife. Prior to the collapse, Corzine had raised at least $500,000 for Obama’s 2012 campaign as one of his top “bundlers.”

Covert Congressional Pressure in the Corzine Case

During a meeting in Washington D.C., a visibly shaken member of Congress confided in me after receiving an unexpected visit from the New Jersey delegation. Their message was delivered with unmistakable clarity: “No criminality pertains to Jon Corzine,” and pushing for an indictment “wasn’t being a good Democrat.” The $5 million fine that eventually materialized represented less than 0.5% of customer losses.

When people question why financial crimes rarely result in criminal prosecutions, they should understand that justice is quietly redirected behind closed doors. There are different standards of accountability depending on one’s political connections, wealth, or status.

Archegos: How Total Return Swaps Led to Market Manipulation

Sung Kook “Bill” Hwang, a South Korean-born American, founded the family office Archegos Capital Management in 2013. The fund peaked at over $36 billion in assets, and his net worth reportedly soared to around $30 billion.

Before forming his family office, Hwang pled guilty to insider trading while working at Julian Robertson’s Tiger Asset Management hedge fund. In 2012, he was fined $44 million and banned from trading in Hong Kong.

Operating as a family office, Archegos faced fewer disclosure requirements than traditional hedge funds, allowing it to operate with less regulatory scrutiny. Archegos used total return swaps to gain exposure to various stock returns without owning the underlying shares. Archegos’s counterparties—banks—held the shares and received fees and interest.

Archegos amassed massive, highly leveraged positions in stocks like ViacomCBS, Baidu, and Discovery. Archegos had built concentrated positions through multiple banks. By the end of March 2021, Archegos had $160 billion in exposure to stocks, well over its available capital.

Archegos’s Key Total Return Swap Abuses

Concealing Exposure

Archegos used highly leveraged total return swaps to create enormous off-balance-sheet exposure to stocks like ViacomCBS and Discovery. TRSs allowed Archegos to bypass public disclosure requirements. For instance, Hwang secretly controlled over 50% of ViacomCBS’s freely traded shares, unbeknownst to regulators, other investors, or even the banks holding the shares.

Market Manipulation

Prosecutors alleged Hwang used TRSs to artificially inflate stock prices by coordinating massive purchases at specific times (e.g., end-of-day trading) to create false impressions of demand, inducing other investors to buy at inflated prices. This manipulation drove Archegos’s portfolio from $1.5 billion to $36 billion within a year.

Deceiving Banks

Hwang and accomplices, including CFO Patrick Halligan, misled banks about Archegos’s portfolio size, liquidity, and risk to secure additional credit. By using multiple banks (e.g., Credit Suisse, Nomura, Goldman Sachs), Archegos obscured its total exposure, preventing any single bank from understanding the full risk.

The misuse stemmed from Archegos’ excessive leverage and lack of transparency. TRS agreements enabled Archegos to bypass public disclosure requirements under the Williams Act, as it was not the beneficial owner of the shares, a tactic previously contested in cases like CSX Corp. v. The Children’s Investment Fund (2008).

Collapse and Impact

In March 2021, falling stock prices, particularly ViacomCBS’s after a failed stock offering, triggered margin calls Archegos could not meet. On March 22, 2021, Viacom announced a #3 billion secondary stock offering. On Tuesday, March 23, its share price dropped 9%. On Wednesday, March 24, the price was down 30% from its Monday high. On Friday, the price dropped 27%. Other large positions in Archegos’s portfolio plummeted, too. On Friday, March 26, Discovery dropped 27%. Selling pressure hit Archegos’s large Chinese tech stock positions, in particular Baidu, GSX Techedu, and RLX Technologies.

Banks liquidated $20 billion in stocks, causing a market crash that wiped out over $100 billion in market value and led to $10 billion in bank losses (e.g., Credit Suisse lost $5.5 billion, Nomura $2.85 billion). Ripple effects continued into 2023 as regulatory scrutiny intensified.

Regulatory Consequences

Archegos collapsed. The SEC charged Hwang, and he was convicted in July 2024 on 10 counts of fraud and market manipulation. In November 2024, Bill Hwang was sentenced to 18 years in prison.

As usual, financial regulators were several steps behind the perpetrators of the financial crash.

Conclusion

Total return swaps are potent leverage, hedging, and portfolio management tools. However, their complexity, off-balance sheet nature, and counterparty risks require careful analysis.

The tempting combination of leverage and opacity creates challenges for financial regulators.

Learn more about TRS with Credit Derivatives and Securitization, 3rd Edition (2023) by Janet Tavakoli, President of Tavakoli Structured Finance.

About the Author

Janet Tavakoli is the president of Tavakoli Structured Finance founded in 2003. She is a globally recognized structured finance expert and derivatives authority who has advised financial regulators, testified as an expert witness in major financial litigation, and authored definitive works on credit derivatives and securitization.

For comprehensive analysis of structured finance products and securitization strategies, consult Tavakoli Structured Finance

Sources and Authoritative References

Regulatory Documentation

CFTC Fact Sheet: Further Definition of “Swap Dealer” – Commodity Futures Trading Commission

SEC Security-Based Swap Rules – Securities and Exchange Commission

SEC Security-Based Swap Dealer Registration – Securities and Exchange Commission

SOFR Reference Rates – Federal Reserve Bank of New York

Case Study Documentation

MF Global Investigation Report – CFTC Investigative Report, June 2012

CFTC Press Release: Jon Corzine Settlement – January 2017

SEC Charges Against Bill Hwang and Archegos – April 2022

Bill Hwang Sentencing – U.S. Department of Justice, November 2024

SEC Settlement: Tiger Asia Management – December 2012

Political Finance Documentation

Jon Corzine Political Contributions – ABC News, December 2011

Obama Campaign Returns Corzine Contributions – Reuters, December 2011

Jon Corzine Biography – National Governors Association

Academic and Professional Sources

Tavakoli, Janet M. Credit Derivatives and Securitization, 3rd Edition. Lyons McNamara, 2023.

CSX Corp. v. The Children’s Investment Fund Management (UK) LLP, 562 F. Supp. 2d 511 (S.D.N.Y. 2008) – Legal precedent on beneficial ownership in TRS arrangements

Congressional Record

• Representative Marcy Kaptur’s Special Order on MF Global – Congressional Record, December 14, 2011

Related Tavakoli Structured Finance Analysis

MF Global Bankruptcy & Jon Corzine’s TRS: $1.6B Went Missing – June 2025

Tavakoli Structured Finance Revokes Credit Rating Agencies’ NRSRO Designation – Rating agency analysis

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