SEFs: Volatility, Please
Aside from the shifting regulatory playing field and buy-side unfamiliarity with the structure, there is a more fundamental cause behind the slow start of swap execution facilities: low volatility that has dimmed the appeal of trading swaps.
“Volumes will pick up once you have a little volatility,” said Shawn Bernardo, chief executive of Tullett Prebon’s tpSEF.
A common swap is an interest-rate swap that exchanges fixed-rate interest payments for floating-rate payments, perhaps for a duration of five years. But defying the expectations of many would-be hedgers and speculators, rates have remained low this year, with scant volatility. The five-year U.S. Treasury note recently yielded 1.69%, little changed from 1.72% at the outset of 2014.
Bernardo expects a seasonal post-summer uptick in SEF volumes, but a broader, more sustainable increase may not be in the offing until 2015. “You’re going to need to see some volatility for SEF volumes to go up. I don’t necessarily believe that you’re going to see that prior to next year,” he said.
tpSEF ranked second in interest-rate volume through midyear with a notional $8.2 trillion in swaps traded, behind ICAP’s $21.9 trillion, according to Futures Industry Association data. Bloomberg, GFI and Tradeweb led in credit default swaps, while BGC and GFI led in foreign exchange. The SEF business commenced earlier this year via regulatory fiat, and market participants and observers note the numbers reported so far are tiny relative to the market’s potential.
But even at this very early stage, it’s important for SEFs to gain or at least keep momentum, as the consensus expectation is that the current field of 19 will winnow substantially, possibly sooner rather than later.
“I do think you’re going to see a few SEFs start to struggle,” Bernardo said. “If you’re a single-product SEF and you have not captured the market share you need to remain viable, it is quite likely that your investors will begin to question whether continued funding is appropriate.”
Broadly speaking, “the implementation process and SEF volumes are, to date, generally consistent with what I expected,” Bernardo said. “Those who expected to see significant interest from the non-dealer community to begin trading in the traditional inter-dealer markets might question the lack of interest thus far. This lack of interest may be due to the fact that the pre-SEF business models were, as I understand it, operating quite well.”
Current initiatives in the SEF space include SEFs who are temporarily registered with the U.S. Commodity Futures Trading Commission applying for permanent registration, and on the regulatory side, the CFTC itself is integrating two new commissioners and a new chairman, while trying to calibrate cross-border trading rules and other thorny issues.
Featured image via gitanna/Dollar Photo Club
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