Buy Side Has Qualms About SEFs

Terry Flanagan

While swap execution facilities have officially been in operation for months, and some trades have been mandatory via SEFs since mid-February, the swaps industry and end users of OTC swaps still have their work cut out for them.

A big regulatory deadline is looming in the form of relief for packaged transactions, or transactions containing multiple swaps, which is set to expire on May 15. There are also issues related to connectivity between dealers and SEFs, and the applicability of SEF rules to cross-border trading venues.

According to a survey of hedge funds, investment banks, broker/dealers and exchanges conducted by IPC Systems during the FIA Chicago conference in November, 60 percent of survey respondents said the industry was behind on meeting the deadline on SEF trading, and 39 percent said their firms were behind in meeting the deadlines.

Whether that situation has changed in the ensuing months is open to debate, but anecdotal evidence suggests it has not.

In the equities world, dealers have a responsibility for best execution, and the buy side has a fiduciary responsibility in how they invest people’s money. A clear distinction has yet to arise in the SEF world.

“The buy side is not homogenous. It includes companies like NYS Electric & Gas, Pennsylvania Power & Light as well as Pimco and BlackRock,” said an industry source. “It’s important to make those distinctions. It’s important to the extent that what it means for these end users who use swaps to hedge risk.”

The expectation is that the Commodity Futures Trading Commission will let its no-action relief expire for the more vanilla packaged transactions, meaning they will come under the made-available-trade umbrella.

“There’s been a lot of discussion regarding packaged transactions,” said Chris Ferreri, head of e-commerce Americas at interdealer broker ICAP. “It appears that a portion of that relief may expire, such as spreads over Treasurys.”

The CFTC has also clarified the conditions that EU-regulated multilateral trading facilities (MTFs), must fulfill in order be granted relief from SEF requirements for transactions involving U.S. persons. An MTF must report all swap transactions to a Commission-registered or provisionally-registered swap data repository as if it were a SEF, in compliance with parts 43 and 45 of the Commission’s Regulations. Qualifying MTFs must also submit monthly reports to CFTC staff summarizing levels of participation and volume by U.S. persons.

The traditional method of executing swaps transactions via the phone isn’t likely to go away with the transition to SEFs.

“We see voice communications as continuing to be very important because even though the market has mandated SEF trading,” said Ganesh Iyer, director, product marketing, financial market network at IPC. “Not all of trading is going to be electronic; voice RFQs are going to be relevant and important for a continued period of time. We do see a very important role for voice broking in this.”

The buy side had expressed similar concerns a year ago regarding the switch to mandatory central clearing, but that transition appears to be going smoothly with the launch of clearing facilities by the major clearinghouses and exchanges.

The estimated amount of collateral in circulation in the non-cleared over-the-counter (OTC) derivatives market decreased 14% from $3.7 trillion at the end of 2012 to approximately $3.17 trillion by December 31, 2013, according to the t International Swaps and Derivatives Association’s 2014 ISDA Margin Survey. Much of this decrease can be attributed to the rise of mandatory central clearing.

The number of active collateral agreements (those with exposure and/or collateral balances) supporting non-cleared OTC derivatives transactions was 133,155 agreements at the end of 2013. Eighty-seven percent of these are ISDA agreements. Responding firms indicated that 90% of non-cleared OTC derivatives trades were subject to collateral agreements at the end of 2013.

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