By Terry Flanagan

SEF Rules Irk OTC Markets

As the Commodity Futures Trading Commission moves toward adoption of a final swap execution facility (SEF) rule, buy-side firms are worried that the rule will be overly restrictive and thus defeat the goals of transparency and systemic risk reduction envisioned by the Dodd-Frank Act.

Buy-side members of industry groups including Sifma, the International Swaps and Derivatives Association and the Managed Funds Association on Friday released a summary of results from a member survey, in which over 84% of respondents indicated that the five request for quotes (RFQ) rule proposed by the CFTC would result in increased transaction costs.

Additionally, nearly 70% of respondents indicated that they would migrate to other markets if required to post five RFQs.

“We continue to believe that only one request for quote is sufficient, which is how the Securities and Exchange Commission has constructed their rule,” said Timothy Cameron, managing director and head of Sifma’s asset management group, in a statement. “The CFTC’s proposed rule is too restrictive of a requirement, which would remove discretion from the asset managers—who are in the best position to decide what number of providers to go out to for any particular trade—and impair liquidity in these products. In the end, it would be Main Street retail investors in funds and pension plans that would be hurt by this rule.”

The survey was conducted in an effort to provide further information to the CFTC as it moves toward adoption of a final SEF rule.

Buy-side market participants are concerned that the SEF rules might increase costs and reduce the availability of tools that they need to risk manage their investment portfolios, which could have adverse consequences to the individual and institutional clients of these firms.

“We are seeing a huge amount of focus and investment into the area of regulatory compliance, with Dodd-Frank deadlines being a high priority,” said Virginie O’Shea, an analyst at Aite Group, a consultancy. “Each month more elements are being agreed, but with very tight deadlines for systems to comply and many knock-on effects of the subsequently released regulations, financial organizations are operating in a tough environment where some short-term fixes may need to be considered.”

The survey results strongly argue for the CFTC to amend their proposal and permit investors that participate in these markets to send a quote request to as few as one recipient, allowing those investors to rely on their own, extensive expertise and experience with these transactions.

For example, respondents said that transactional costs would increase and anticipated other increased costs (e.g. new legal arrangements) when asked how the rule would affect swaps traded on SEFs.

Buy-side firms want to limit the number of bids because of concerns over exposing their investment strategy to market participants.

According to the survey, 76% of respondents indicated the CFTC’s minimum-of-five RFQ rule would have a negative effect on liquidity and 68% of participants said they would look to trade an instrument that is not required to be SEF traded instead.

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