Sizing Up SEFs

Terry Flanagan

The buy side remains ambivalent about swap execution facilities, viewing them on the one hand as a threat to their traditional OTC trading relationships but on the other as holding the potential for technological innovations as has occurred in other asset classes.

“The SEF mandate has added a horizontal model relative to the vertical model we have with futures,” Supurna VedBrat, managing director of electronic trading and market structure for BlackRock’s trading and liquidity strategy group, said during a panel discussion at Wednesday’s Sefcon V conference in New York. “The idea was that it would help to generate more product innovation, and not allow monopolies to form. We have protocols like RFQ and central limit order books in other markets, and those are now being thought through for trading interest-rate swaps.”

SEFs officially launched a year ago, and trading commenced in February with the Made Available to Trade (MAT) determinations. Since then, the SEF markets have become bifurcated, with dealer-to-consumer platforms such as Bloomberg competing with dealer-to-dealer platforms run largely by the interdealer brokers: BGC, GFI, Icap, Tradition, and Tullet Prebon.

Trading in interest rate swaps and other non-FRA (forward rate agreement) instruments reached $1.02 trillion in the week of Sept. 8, the highest level since June, according to the Futures Industry Association’s SEF Tracker. Tradeweb’s share of non-FRA volume peaked at 16.8% in the week of Sept. 8, a record for that SEF. BGC and Bloomberg also gained market share in non-FRA trading in September.

While the majority of buy-side users continue to prefer trading via name give up request for quote (RFQ), which is most similar to the old way of phone trading as is possible under the CFTC’s rules, the new market structure has only just started to take shape, with many opportunities still on the table for incumbent, inter-dealer broker and new entrant SEFs, according to Greenwich Associates.

“I’m a big believer in diversity of competition,” Yanfeng Chen, head of interest rate swap trading at Citadel Securities, said during Wednesday’s panel discussion. “There should be a diverse range of liquidity providers. There should be a diverse range of different SEFs. There should be a different range of execution methods, from fully name give up RFQ to fully anonymous CLOB. This will provide choices to end users. If you believe that by giving up your name you’ll get a better price then you can use RFQ. If you like the fully anonymous CLOB then you have an option.”

The majority of new OTC derivatives electronic infrastructure will continue to be built or made available as independent communities, so it’s vital for OTC derivatives market participants to join these communities as soon as is possible, according to Aite Group.

“Despite shared infrastructure and open standards, market participants must be the ones to demand integration of electronic OTC derivatives systems into front ends and GUIs,” said David Weiss, senior analyst in institutional securities & investments at Aite Group, said in a release.

“Such integration is now lagging behind what market participants have taken for granted for decades in listed markets, and desktop real estate is already at a premium, so much work still needs to be done.”

It’s incumbent on the buy side to make itself more efficient in the way it accesses OTC liquidity, VedBrat said. “Granted it’s fragmented, and that’s where technology partners and trading technologies becomes instrumental in making it efficient for us to trade,” she said.

The goal, VedBrat said, is to be able to “tap into some of the D2D liquidity that was traditionally separate from D2C liquidity.”

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