Markets Gauge SEF Proposals

Terry Flanagan

Participants urge CFTC to take a less-prescriptive approach with execution methods.

Market participants are stressing the need for flexibility in the rules around swap execution facilities and improving synergy between the rules proposed by the CFTC and SEC, especially  on allowing market participants choose the appropriate number of liquidity providers to seek pricing from in an RFQ versus the minimum of 5 dealers currently proposed by the CFTC.

“The CFTC should be more accommodative of execution methodology,” Ed Brown, executive vice president of business development and research at ICAP, told Markets Media. “The transition from a purely voice-brokered market to an electronic market, as has occurred with FX and fixed income, and now with OTC derivatives, is typically market-driven, and hence the CFTC should not limit the execution methodology employed.”

Dealers, inter-dealer brokers, and industry groups have spoken out against proposed CFTC rules that would impose minimum quoting request for request-for-quote systems and a mandatory 15-second pause. They argue that the agency is seeking to import constructs from exchange-traded futures into OTC derivatives, which is a vastly different market.

The CFTC has proposed that participants using a request-for-quote facility must send the request to at least five participants. Requiring bids or offers from five dealers may make dealers hesitant to price the transaction aggressively as at least four other market participants would know their position, and could reduce liquidity.

Additionally, SEFs must provide a general timing requirement applicable to traders such as brokers who have the ability to execute against a customer’s trade (internalization) or are entering a trade for two customers on opposite sides of the transaction (crossing).

Under the CFTC’s proposal, a broker would have to provide a minimum pause of 15 seconds before entering the second side (whether for its own account or for a second customer), during which time the order would be exposed to other market participants and allowing them to join in the trade.

Dealers argue that the 15-second delay is a carryover from the futures and options world, where exchanges typically require a delay in order to prevent manipulative pre-arranged executions, and isn’t applicable to the trading off swaps on SEFs, which lack a central order book.

A consensus is emerging among industry participants that the CTFC’s approach is far more prescriptive compared to those being taken by the SEC and by European regulators, who are adopting a “principles-based, less restrictive approach to rule making.

The SEC, for example, doesn’t specify how many participants must be asked for quotes, nor does it require each SEF to know the full market position of every participant.

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