SEF Rules Inhibit Cross-Border Trades

Terry Flanagan

Recent regulatory rulings have resulted in a shift in trading in euro- and U.S. dollar-denominated interest rate swaps. The Commodity Futures Trading Commission, through its MAT (made-available-to-trade) determinations and its recent tightening up of rules regarding European MTFs (multilateral trading facilities), is causing overseas swap market participants to think twice about entering the murky water of SEFs.

The CFTC has clarified the conditions that EU-regulated multilateral trading facilities (MTFs), must fulfill in order be granted relief from SEF requirements for transactions involving U.S. persons. An MTF must report all swap transactions to a Commission-registered or provisionally-registered swap data repository as if it were a SEF, in compliance with parts 43 and 45 of the Commission’s Regulations. Qualifying MTFs must also submit monthly reports to CFTC staff summarizing levels of participation and volume by U.S. persons.

“For the MTFs, they’ve added some clarity to the original relief,” said Dan Marcus, head of Trad-X, the SEF operated by interdealer broker Tradition. “What they’ve done is, to be treated as substituted-compliant to a SEF, the MTF basically has to comply with more CFTC SEF Rules to make the MTF more ‘SEF like.'”

This introduces more of a regulatory burden on an MTF to enable by making it more equivalent to a SEF. “The issue is, does anyone actually want to do that?” said Marcus. “Is there going to be any trading of MAT products – USD, EUR and GBP, between U.S. persons in Europe. I don’t know the answer to that, yet, but we are carrying out a market analysis to assess whether the demand means we apply for such relief.”

The CFTC MAT rule means bilateral trading of certain USD, EUR and GBP swaps is now prohibited by counterparties subject to the SEF requirements. Acceding to an analysis by the International Swaps and Derivatives Association which measures changes in MAT swaps before and after the February 15, 2014 effective date, USD MAT swap volume increased while EUR MAT swap volume sharply decreased as a percentage of total SEF volume.

“As a result, SEFs are becoming even more USD-centric, offering less liquidity to EUR and GBP MAT trading,” Isda said in a report.

Changes in trading behavior had occurred between European and U.S. dealers once the SEF regime had come into force on October 2, 2013. European dealers began to trade exclusively with other European counterparties in the market for EUR interest rate swaps and had dramatically moved away from trading with U.S. counterparties. The resulting market fragmentation created separate liquidity pools for US and non-US persons.

This appears to substantiate findings of an earlier Isda survey in October 2013, which reported that 84% of survey participants believed non-U.S. persons were choosing not to trade on a SEF.

“Participants predicted this shift away from SEFs would be exacerbated once swaps were made available to trade. This important dynamic is the focus of this analysis, as MAT swaps must trade on a SEF and are no longer permitted to be transacted bilaterally,” according to Isda.

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