SEFs Strut Their Stuff

Terry Flanagan

Swap execution facilities touted the theme of “open for business” at an industry confab in New York on Monday.

The fourth annual SEFCON conference celebrated the launch of multiple SEFs trading OTC swaps across multiple asset classes.

Final SEF rules were approved in May but took effect only a few weeks ago, not without irony.

“On the day that the OTC swap market was transformed into a thoroughly regulated market, our government was shut down with only 28 of more than 600 CFTC staff at work,” said Chris Ferreri, chairman of SEFCON IV and head of e-commerce Americas at interdealer broker Icap. “We have filled out thousands of pages of applications, have onboarded hundreds of traders, and 21 SEFs have been temporarily registered, The incumbents are leading, but it’s still too soon to call the race.”

With the expectation that most interest rate and credit derivative products will be required to trade on either a swap execution or an exchange in early 2014, SEFs have been building out the nuts and bolts to support the multitrillion dollar market, such as trading systems, connections to CCPs and swap data repositories, and credit risk checks.

Mandatory trading will commence early next year when the MAT [Made Available to Trade] rules take effect. A few SEFS have filed MAT self-certification, but the CFTC is reviewing those applications, which won’t be completed until February.

The pace of rulemaking has been relatively brisk this year, with rules governing mandatory clearing and SEF trading going into effect. The deadline for SEF registration was October 2, but the Commodity Futures Trading Commission extended the compliance deadline for another month.

The CFTC ruled, via Footnote 88 in its final swap core requirements, that permitted transactions (transactions that are not subject to mandatory clearing) must be traded on a SEF along with required transactions (those that are subject to mandatory clearing), as long as the platform on which they’re traded is multi-dealer.

“We have faced issues such as unforeseen policy implications from footnotes, unclear interpretation of what constitutes straight-through processing, how to handle trades rejected by clearinghouses, as we; we logistical challenges from writing rule books, onboarding customers, and developing and testing technology,” said Shawn Bernardo, chairman of the Wholesale Markets Brokers Association Americas, and CEO of Tullett Prebon’s SEF. “Comparing the SEF implementation timeline with other regulatory overhauls, we’ve had an unprecedented amount of work to do in a shockingly compressed amount of time. When we were tested, we performed admirably.”

Footnote 88 increases the number of swap transactions, and therefore the complexity, associated with reporting to SDRs and CCPs. “According to the footnote, the clearing mandate doesn’t factor into SEF trading,” said Ferreri. “If you are trading multiple to multiple intermediating swaps, you’re acting like a SEF.”

By not tying the clearing mandate to the SEF execution process for intermediaries, the effect of footnote 88 was to move trading away from SEFs.

“If you’re acting like a SEF, you have to register as a SEF, but swaps aren’t required to trade on a SEF,” Ferreri said. “That footnote broadened the product set from the mandatory cleared products of rates and credit to the entire set of CFTC-regulated swaps and brings in FX, equity and commodity swaps.”

Footnote 88 also has implications for cross-border transactions. Since multiple to multiple platforms trading bilateral contracts are now required to be SEFs but without any mandate to actually trade on the SEFs, some market participants have used an interpretation of the rule to avoid trading on SEFs, said Ferreri.

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