CFTC To Consider Final SEF Rules

Terry Flanagan

Regulators are closing in on final rulemaking to implement the swaps execution provisions of the Dodd-Frank Act, as rules mandating central clearing are close to kicking in.

The Commodity Futures Trading Commission on Thursday will hold a hearing to consider core principles and other requirements for Swap Execution Facilities (SEFs), procedures to establish minimum block sizes for off-facility swaps and block trades (Swaps Block Rule), and the process for a Designated Contract Market or SEF to make a swap available to trade.

The CFTC is reportedly mulling lowering the number of price quotes a buyer is required to request before trading swaps, from five to two.

Buy-side members of industry groups including Sifma, the International Swaps and Derivatives Association and the Managed Funds Association in March released a summary of results from a member survey, in which over 84% of respondents indicated that the five request for quotes (RFQ) rule proposed by the CFTC would result in increased transaction costs.

Additionally, nearly 70% of respondents indicated that they would migrate to other markets if required to post five RFQs.

“This differs from current market practice and could have a significant negative impact on the liquidity in the swap market,” said Ken Bentsen, acting president and CEO of Sifma, in a comment letter. “By signaling to the market the desire to purchase a swap, customers may be telegraphing important information that may impede best execution of their orders.”

The Commodity Futures Trading Commission has proposed a rule to define when a particular swap has been “made available to trade,” or MAT for short.

One concern is that the MAT determination may influence the determination on whether a swap should be subject to clearing.

In the view of many market participants, execution and clearing should be kept separate. Not all swaps that are required to be cleared will be available to trade solely by the creation of a cleared market. The amount of liquidity necessary for MAT is greater than that necessary to facilitate clearing of the swap.

Swaps with even a limited amount of liquidity could potentially become subject to mandatory clearing without disrupting the market, but a mandate to trade certain less liquid swaps through a SEF requiring pre-trade transparency could effectively kill liquidity in those instruments.

The central clearing requirements, meanwhile, are scheduled to kick in on June 10 for most buy-side institutions, many of which are scrambling to bring themselves into conformity with the new rules.

“There is no time to waste for Category Two firms that expect to trade swaps after June 10,” said Sean Owens, director of fixed income at Woodbine Associates, in a report. “Meeting the requirements for the deadline is no small measure. Category Two firms must rapidly select, register with, and put in place documentation with FCM, CCP and technology partners.”

The applicability of central limit order books (CLOBs) to swaps trading is a hotly-debated topic among market participants, who are concerned that if a block trade were required to interact with other trading interest on a SEF, there might not be enough liquidity on the SEF to execute the entire block trade, leaving a portion of the block trade unexecuted.

Market participants have urged exceptions for the handling of block trades, including the ability to negotiate and execute block trades without having to interact with resting orders.R

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