Speaking Of SEFs

Terry Flanagan

The adoption of final rules on swap execution facilities (SEFs) by the Commodity Futures Trading Commission has triggered a lively debate within the derivatives community.

On May 14, 2013 the CFTC finalized the rules requiring eligible swaps to trade on Swap Execution Facilities (SEFs). This concludes over two years of deliberations by the CFTC over the most effective way to regulate the over-the-counter swaps markets, with the intention of bringing greater transparency to this previously unregulated marketplace.

Once the rules have been published in the Federal Register, the timeline for implementation will come into effect. Sixty days after the rules are published prospective SEFs who have received temporary authorization from the CFTC may begin operating as SEFs.

“Now that the CFTC has provided some clarity around SEFs, swap dealers, buy-side firms and corporations can begin the long-overdue process of complying with the second key plank of Dodd-Frank ¬ central trading on a regulated exchange,” said Zohar Hod, global head of sales at SuperDerivatives.

“All eyes are now on the trading platforms that have been waiting in the wings to become registered SEFs,” Hod said. “Many have been claiming they were ready for months, and they now control their own fate. Of course, not all of the 20+ SEFs will survive; ¬ultimately, technology, volumes, liquidity and connectivity will decide the outcome over the next 12-18 months.”

Among the major issues was a proposal to require market participants to seek five price quotes on trades done on a swap execution facility. The CFTC ultimately voted to mandate two “request for quotes” (RFQs), with the requirement eventually increasing to three.
“How or why is it “good” to mandate that a derivatives user request a certain number of price quotes from different dealers? And why five?” the International Swaps and Derivatives Association (Isda) said in a blog.

“Shouldn’t this be up to market participants to decide?” Isda said. “Particularly since getting a quote is easy enough, given the different ways derivatives users can get or check prices (via phone, terminals, and dealer, broker and other trading systems)?”

The flawed assumption is that the client is not qualified to decide for itself whether 2, 3 or 23 quotes are optimal, according to Isda. “It also ignores the fact that information has value for the recipient of the quote requests and the client might not want to offer that information to any more counterparties than is appropriate to the situation.”

Although majority of the larger swaps dealers have been preparing for SEFs since 2010, medium and smaller buy-side firms and non-financial participants, such as asset managers and corporations, now face a race against time to comply.

“This will require investment in technology that delivers market data, pre- and post-trade analysis, pricing and revaluation,” said Hod. “They will now need to get up to speed fast, and the quickest and most cost-effective way to do this is through a cloud-computing solutions.”

Isda took note of “the presumption that these trade execution rules have anything to do with reducing risks in the financial system. Trade execution is about market structure – not systemic risk. If the goal of financial regulatory reform is to reduce systemic risk, shouldn’t we focus on issues that affect it, like regulatory capital, clearing, margining and regulatory transparency?”

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