Market participants and regulators should prepare for system errors and liquidity issues ahead of mandatory trading on swap execution facilities (SEFs), Walt Lukken, CEO of derivatives industry body the Futures Industry Association (FIA), has told theTRADEnews.com.
Made available to trade, or MAT, rules will form the de facto deadline for mandatory SEF-based swaps trading, and will take effect from 18 February for interest rate swaps and 26 February for credit instruments.
Lukken said this historic shift, in combination with clearing OTC derivatives through central counterparties (CCPs), constituted a period of adjustment for the market.
“The shift to mandatory trading on SEFs and clearing through CCPs is an exciting time, but there will very likely be glitches along the way that need to be worked out between the industry and regulators – it's a very pragmatic time where we will see the reality of how these rules fit into the market,” Lukken said.
Currently 21 SEFs have received temporary registration from the Commodity Futures Trading Commission (CFTC) although not all have begun trading since 2 October – the earliest date SEFs could execute orders.
Five SEFs have submitted MAT proposals, which will define the products mandated for trading across the universe of swap venues and four of these –Javelin SEF, Tradeweb (which operates two SEFs), trueEX and MarketAxess, - have gained approval, with one from Bloomberg SEF expected in March.
Lukken said there was a possibility of liquidity temporarily dropping as participants adjusted to SEF trading and urged regulators in the US and abroad to be ready to tweak rules to reduce inefficiencies in the market.
“Addressing potential liquidity issues around cross-border elements of swaps trading on SEFs will be key to the success of this new market structure, as there is some concern of US firms avoiding a presence in Europe or vice-versa because of divergent rules,” he said.
The post-crisis push to regulate the US$400 trillion OTC derivatives market since the Group of 20 countries met in 2009 has resulted in a regionalisation of rules for this global market, prompting on-going concerns around the extraterritorial impact of swaps rules.
Earlier this month, the International Swaps and Derivatives Association released a research note detailing a marked drop in cross-border activity between US and European firms due to different swaps rules and the definition of US person, which required some non-US entities to meet CFTC rules when trading with US counterparts.
“This type of balkanisation is not healthy for our marketplace, and we would support efforts to avoid potential cross-border liquidity fragmentation,” Lukken said.
The CFTC will welcome a new chair Timothy Massad, in the coming weeks. Massad joins from the US Treasury and arrives during a key implementation period for rules governing the OTC derivatives market, crafted under the leadership of his predecessor, Gary Gensler.
Lukken said the FIA welcomed Massad’s arrival, describing him as a skilled problem solver with a proven track record through his work on the Troubled Asset Relief Program, or TARP, in the wake of the financial crisis. He added Massad will be tasked with developing solutions to any problems the industry encounters as participants shift to SEF-based execution and central clearing.