Many OTC instruments too illiquid to be ‘made available to trade.’

The CFTC’s proposed rules on swaps trading are raising hackles on the part of market participants, who say that the rules leave the definition of when a particular swap has been “made available to trade,” or MAT for short.

The proposal provides that DCMs and SEFs will make the determination of when a swap has been made available to trade by considering seven enumerated factors, or any other factor that the DCM or SEF may view as relevant. The DCM or SEF may base its determination on any combination of the factors, or on a single factor.

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

“Regarding the linkage between execution and clearing, even the CFTC seems to be confused on this point, George Bollenbacher, financial industry consultant at Kinetix Trading Solutions, told Markets Media. “My conversations with CFTC staff have resulted in statements that any contract mandated to be cleared must be executed on a DCM/SEF, and that it wasn’t required. There was even some confusion on their part as to whether being MAT resulted in an execution mandate.”

Once such a MAT determination is final, all other DCMs and SEFs are obligated to determine whether they list or offer the same, or an economically equivalent swap, and if so, they must treat the swap or economically equivalent swap as having been made available to trade.

There is a fundamental split among commenters, with some preferring a determination by the Commission itself, and others preferring that the regulated execution facilities make this determination.

Commenters who support a Commission determination have suggested that the regulated facility could have incentives to prematurely make certain swaps available to trade in order to mandate trading in these instruments on their platforms.
“The proposed definition of ‘available to trade’ is not a definition at all,” according to Morgan Stanley. “It essentially says that ‘available to trade’ is what any of several conflicted parties says it is.”

The incentive for a DCM or SEF to make MAT determinations are underscored by the history of central execution markets, which reflects that a significant, and perhaps insurmountable first-mover advantage exists for the trading facility that first brings a given product to market.

Once a trading facility begins offering a new product, and establishes itself as the market for that product, it becomes very difficult for another facility to capture market share. Consequently, said Morgan Stanley, DCMs and SEFs will have powerful incentives to capture first-mover advantage by making MAT determinations before their competitors do.
“The result would be to eviscerate the MAT provision and undermine to existing OTC market,” said Morgan Stanley.