Nearly half of respondents to The TRADE’s October poll believe institutional investors have avoided engaging directly with swap execution facilities (SEFs) until mandated to do so.
Asked how the buy-side would approach the beginning of SEF trading on 2 October, 46.67% believed asset managers would wait on the sidelines. Performing a few test trades received the second highest number of responses with 43.33%, while trading regularly from the outset received 10% of votes cast.
SEFs began trading on 2 October as part of Dodd-Frank Act measures to increase transparency in the opaque OTC derivatives market in addition to pushing the most commonly traded swaps towards centralised clearing.
Commenting on the results, Sean Owens, director, fixed income at consultancy Woodbine Associates, said the results were broadly in line with expectations, but added this was driven by liquidity, which had remained concentrated in traditional OTC derivatives trading executed through banks.
“There is currently little impetus to trade on SEFs so the high number of respondents electing to ‘wait on the sidelines’ makes complete sense,” Owens told theTRADEnews.com.
“Participants will continue to trade where they can get the best liquidity, which is still bilaterally and volumes reflect that although this will all change once the trading mandate takes effect for ‘made-available to trade’ (MAT) swaps. Then we will see the beginning of more meaningful SEF volume numbers.”
Under the MAT rule, market participants are required to trade swaps on a SEF if offered by any SEF – a rule developed by the CFTC to spur the migration to SEF-based trading.
“The low number of those trading regularly from the outset is related to liquidity too, but also to connectivity and technology issues of both SEFs – who continue to fine-tune their systems – and buy- and sell-side counterparts finalising agreements and processes.”
Learning curve
Owens believes the market will experience a learning curve once mandated trading begins as participants decide which models – central limit order book or request-for-quote, for instance – favour their trading strategies, and which platforms receive the dominant market share.
The beginning of SEF trading was marked by the partial shutdown of the regulator, as the Commodity Futures Trading Commission (CFTC) whittled its staff of 680 to just 25 during the month’s government shutdown. Despite this, a number of the 18 SEFs approved from 2 October displayed strong volumes from the outset.
Tod Skarecky, senior vice president, Americas for OTC derivatives technology provider Clarus Financial Technology, who has tracked SEF trading volumes during the initial weeks of trading said Bloomberg’s plan to offer a wide range of OTC derivatives products – across credit and rates – had found success, while the more common specialisation strategies had also shown value, particularly for inter-dealer brokers (IDBs).
“The results seem to be in line with what we are hearing,” Skarecky told theTRADEnews.com.
“I personally do not see much growth in SEF activity happening, outside of the IDB’s, for a couple months still because the incentive isn’t there and the regulation [to mandate trading] is at least a couple months away,” he said. Skarecky also believes the number of SEFs will reduce considerably in the next year, with the number of platforms halving within this period.
Leonard Nuara, president and co-founder of TeraExchange, one the platforms that has received temporary approval from the CFTC to operate as a SEF, commented that the poll results showed the buy-side was understandably showing caution during this period of transition in the swaps market.
“The clients we speak to are indeed moving carefully and are in testing with us and their clearing members. From what we’re told by major asset managers and hedge funds, an all-to-all marketplace remains their preferred way to trade but are taking a conservative and measured approach to starting up,” Nuara said.
“But, with all the new CFTC SEF regulations no-action letters and staff guidance letters in recent weeks, it’s not a surprise that electronic swaps trading is taking time to kick in,” he said.