Connecting to SEFs: An Industry Problem

Terry Flanagan

The need for large broker-dealers to connect themselves and their customers to swap execution facilities was foreseen as soon as the ink had dried on the Dodd-Frank Act by one Wall Street technology firm.

“We began looking ahead at what’s going to happen if we do have lots of new trading venues entering this space, and how potentially it’s going to make life very difficult for participants to connect to all the SEFs,” said Sassan Danesh, partner at Etrading Software, a capital markets technology consultants. “Nobody will know where liquidity will end up. I think it will be a challenge to actually advocate that liquidity is present if connectivity to the SEFs is difficult.”

That got Danesh and his colleagues in the investment banking community to start thinking: Wouldn’t it be a good idea if they all adopted the common swaps trading protocol?

In this case, 14 broker-dealers approached Etrading Software on what was effectively a syndicated consultancy model. “The goal was for us to actually work with both the broker-dealers and with the SEFs to agree a common industry protocol for trading swaps electronically for IRS and CDS.”

Driven by the influx of trading venues as a result of the Dodd-Frank regulation, the banks were seeking an electronic messaging standard that increased efficiency, improve accuracy and provide better control over client permissioning in time for the SEF go-live in the latter part of 2013.

The result, the Trading Enablement Standardization Initiative (TESI), is a collaboration initiative launched by the investment banking community and Etrading Software to promote an open standard for the enablement, permissioning or configuration of dealers and their clients across external electronic trading platforms and internal single dealer platforms.

“Every SEF bar one has actually adopted that protocol,” said Danesh. “So that’s an example of the kind of market structure change that we look at where technology and in particular standardization can help optimize that market structure.”

The complexion of trading on SEFs is already starting to change less than two months after their mandatory trading date: whereas initially the trading was almost entirely dealer-to-dealer, volumes are now about evenly split between D2D and dealer-to-consumer.

“D2C is roughly equivalent to D2D activity,” said Tod Skarecky, head of research at Clarus Financial Technology, in a blog posting.

In fact, for the week of March 10-14, D2C accounted for more EUR and USD vanilla “swaps” than D2D, prompting Skarecky to ask: Does D2D and D2C make sense anymore?

“We’ve heard the debate many times,” he said. “Given “Open Access” and “All to All”, does this analysis even make sense anymore?”

Etrading Software’s base has historically has been the big broker-dealers, given that Danesh and his co-founder both had broker-dealers background, and the obvious client base was the organizations that they understood well. That’s beginning to change now.

“What we started doing was helping with implementation of trading technology,” Danesh said. “We still do that, but we’re now working with the broker/dealer community as a whole, actually looking at inefficiencies in the market structure and how those inefficiencies can be ironed away.”

Danesh continued, “The buy side are beginning to realize that they can’t just delegate all that to them sell side and some of the venues are also thinking along similar lines, so certainly our discussion is now broadening and encompassing all the key players who look forward to what is happening to the market structure and what should happen.”

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