Swap execution facilities are preparing for a regulatory go-live date of Nov. 1, and market participants are sorting out what they have to do with regard to connectivity and compliance.

But beyond the nuts and bolts of operating a SEF and trading on a SEF, there are broader, longer-term issues to consider, including how the competitive landscape will shake out.

Since late July, the U.S. Commodity Futures Trading Commission has approved 17 temporary SEF registrations, according to its website. SEF operators range from name-brand financial data providers Bloomberg and Thomson Reuters, to established bond-trading platforms such as Tradeweb and MarketAxess, to newer firms looking for a foothold, including TrueEx and Javelin. Market participants expect the CFTC to approve more SEF operators, further muddying the near-term waters.

And while it remains to be seen which business model or models will ultimately win out, market participants have some definite ideas about what characteristics SEFs will need to succeed.

“Existing client connectivity, reputation, dealer support, ability to attract buy-side liquidity, ability to meet strict compliance requirements, product offerings, ease of doing business, and sufficient working capital are all factors that will come into play,” said Atanas Goranov, managing director and derivatives risk officer at Guardian Life Insurance, which manages about $35 billion.

CFTC-approved SEFs include Thomson Reuters, ICAP, tpSEF (owned by Tullett Prebon), INFX (Integral Development), Tradition, 360 Trading Networks, TruEX, ICE Swap Trade (IntercontinentalExchange), Javelin, BGC Derivative Markets, TeraExchange, SwapEx (State Street), GFI, TW and DW (both Tradeweb), MarketAxess, and Bloomberg.

“Some of these SEFs have parent companies that have historically delivered electronic execution and have solid existing client bases,” Goranov told Markets Media. “Some of them are new, standalone ventures with no legacy constraints that are able to offer innovation, and some are associated with inter-dealer brokers that are experienced in serving the space. Each group has its own unique competitive advantages, but it is very likely that over the next couple of years we will see some consolidation.”

For now, SEF competition is largely notional, as late last month the CFTC postponed a key date for mandatory trading via SEFs by 30 days, to Nov. 1. At an industry conference this week, CFTC Commissioner Scott O’Malia said that of 7,100 swaps trades executed in the U.S. since Oct. 2, only 50 transacted electronically.

But the value of the global swaps market is estimated at $600 trillion to $700 trillion according to the Bank for International Settlements. Even if only a tiny sliver of that trades on SEFs, that could be enough to sustain a vibrant business with multiple players.

“The SEFs that succeed will be those that have a strong product offering, relationships, and very good credit ratings,” said Anthony Buzzi, chief operating officer at Maritime Capital. “Those that do business correctly will win a majority of business.”

Established vs. Start-Ups

With regard to the upcoming SEF competition, market participants and observers note that the field can be broadly split into those with established related businesses such as dealer-to-client platforms or inter-dealer broker platforms, and the start-ups.

SEFs in the first group typically have proven technology, a strong and a reasonably diverse revenue stream, and deep pockets. “They have a platform, they just haven’t deployed it this way before,” said Paul Hamill, head of eCommerce for rates and credit at UBS. “It’s more of a change for them, rather than a completely new business.”

Start-from-scratch SEFs in the second group may or may develop better business models, but they will need to prove themselves, execute on their vision, and possibly ride out some lean times.

Client order flow will be the ultimate arbiter as to which SEFs thrive and which wither.

“The market should be allowed to figure that out and reward the SEFs with the best business model,” said Patrick Hickey, head of market structure at Optiver, a proprietary trader and electronic market maker. “There are similarities to products at traditional exchanges — just because somebody designed the perfect product on the perfect platform, doesn’t mean it’s going to be a success. There needs to be a group of participants that feel compelled to actually make a trade.”

The SEF business is not expected to be profitable from day one. “But for the person who wins a decent amount of market share, especially if we see volumes increases, it’s definitely a viable business model especially on the swap side,” said Hamill of UBS.