Institutional investors are likely to hold-off on using swap execution facilities (SEFs) when they go live in the US next week amid concerns that some segments of the market are not ready.
On 2 October, the first SEFs will go live and begin trading swaps. But with more than 15 new venues set to begin trading on Wednesday, the swaps market is likely to be chaotic in the coming weeks.
“I think in the early days of SEF trading we’re mostly going to see the sell-side engaging, but I think the buy-side will want to take more a wait-and-see approach,” said David Weiss, senior analyst at consultancy Aite.
While SEFs must be ready to begin trading on 2 October, market participants will not initially be required to trade swaps on SEFs. Mandated SEF trading is expected to come in late in 2013 but an exact date has yet to be confirmed. This means there won’t actually be any contracts registered to be traded on a SEF on 2 October.
“When we go live, there’s nothing to stop market participants from continuing to trade bilaterally in the interim. We may even see a rather odd situation where electronic trading actually goes down on 2 October until participants are mandated to trade on SEFs,” explains Jim Rucker, credit and risk officer at MarketAxess, which is launching a SEF focused on credit derivatives.
Last-minute clarity
Despite SEFs being less than a week away, there were still several areas of confusion because the Commodity and Futures Trading Commission (CFTC) had not provided sufficiently clarity. Late on Thursday a letter was sent out to SEFs and futures commission merchants (FCMs) containing more complete rules.
“With only a few days to go before the go live date, there were several areas that we still didn’t have clarification on. The CFTC has now provided these much-needed clarifications, so we’ll be working hard to ensure we incorporate them into our rule book in time for 2 October,” said Rucker.
The CFTC confirmed its position on pre-trade credit checking, trade fails and acceptable execution agreements.
Some firms have already been urging the CFTC to delay the 2 October date, amid fears that it would be impossible for firms to implement everything in time. However, the regulator has said it will not extend the deadline but may issue no-action relief on a targeted basis for those firms that aren’t yet ready.
Weiss believes the implementation of SEFs is unlikely to go smoothly given the lack of readiness.
“If we look back at the OTC clearing deadlines earlier this year, even though most firms were already clearing other products and used to the process, it was still very messy in its implementation,” he said. “Compared to clearing, SEFs are completely new and there’s lots of models out there and different interpretations so I expect there will be issues cropping up in the first few weeks.”