The U.S. Commodity Futures and Trading Commission, in drafting rules for swap execution facilities, was placed in an uncomfortable position of reconciling the OTC and listed derivatives markets.

On the one hand, the Dodd-Frank Act made clear that swaps must be offered on one-to-many platforms, but on the other hand, the CFTC had nothing to use as a starting point for rulemaking other than the futures exchange model.

“If you look at the part 37 rules, and you look at the statements of (former) Chairman Gensler, Commissioner Wetjen and (former) Commissioner Chilton at the open meeting where they adopted the rules, they all made very clear their belief and intent that the rules are being done in a technology-neutral way that would allow any means of interstate commerce to be used for trade execution,” said Matthew Kulkin, principal at Washington, D.C.-based Squire Patton Boggs.

Dodd-Frank defined a SEF to be “a facility, trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by other participants that are open to multiple participants in the facility or system, through any means of interstate commerce.”

“Where some of the friction lies is that in interpreting the rules now, the CFTC staff are frequently relying on their futures market or exchange-based rule disposition, and the application of a futures concept to an OTC market is proving to be quite frustrating,” Kulkin said.

Dodd-Frank refers to SEFs as “Alternative Swap Execution Facilities,” indicating some sort of alternative liquidity formation, or liquidity platform that was distinct from the exchanges.

“Fast forward a year and a half after so many registrations, and a year plus after the rules go into effect, I don’t think there’s anything alternative about them, so credit should be given to the drafters of Dodd-Frank to recognize that these were actually primary swap execution venues,” said Kulkin, “and for making clear in statute that there should be a competitive, transparent, vibrant OTC market for swaps and not just the exchanges.”

Currently, SEFs are classified according to whether they are interdealer or dealer-to-customer, but it’s likely that the two categories will blend over time.

“One story that is yet to play out for the competitive landscape is the traditionally inter-dealer broker SEFs,” said Kevin McPartland, head of market structure and technology research at Greenwich Associates. “I think we’re going to start to see them look more toward the buy side, and the buy side look a little bit more at them and start putting a more real money flow on some of these traditionally inter-dealer platforms.”