Industry speaks out against CFTC’s SEF quote rules

A last-ditch lobbying effort from three US trade bodies has emphasised the hike in buy-side trading costs that may result from swap execution facility rules.

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A last-ditch lobbying effort from three US trade bodies has emphasised the hike in buy-side trading costs that may result from swap execution facility (SEF) rules.

A survey conducted by the International Swaps and Derivatives Association, sell-side trade body the Securities Industry and Financial Markets Association and the Managed Funds Association found that the buy-side believes initial proposals from the Commodity Futures Trading Commission (CFTC) to source a minimum of five quotes for OTC derivatives trades would increase costs and harm liquidity.

The concerns have been raised prior to next month’s release of final SEF rules by the CFTC, which is responsible for the trading of index- and commodity-based swaps under Dodd-Frank. The final rules have been due for some time, but debate on the minimum quote obligation is believed to have slowed progress.

The need to request quotes from five dealers was included in the CFTC’s initial SEF rule proposals in 2011. The aim is to encourage transparency and wider competition among liquidity providers in the swaps market.

But almost 70% of buy-side respondents to the survey said they would migrate to other markets if they were required to source five quotes and 68% would seek alternative exposures via instruments that are not traded on SEFs. Buy-side respondents also anticipated a negative impact on SEF-traded contracts generally, with 87% foreseeing increased transaction costs, 82% predicted a widening of spreads and half believing the five quote limit would slow swaps market development.

SEFs are a core pillar of the new rules governing OTC derivatives under the Dodd-Frank Act. In addition to trading standardised swaps on SEFs, trades will also have to be centrally cleared and reported to newly created repositories.

By comparison, the SEC, which has oversight for ‘security-based’ swaps, did not place any restrictions on the number of quotes that need to be sourced in its SEF rules.

This lets the buy-side firms decide on the number of quotes it sources when trading swaps depending on the sensitivity of trading information.

The trade bodies’ survey revealed that 84% of the buy-side limit the number of quotes they source because of concerns over exposing their investment strategy to other market participants. Furthermore, 87% limited the number of quotes because of trade size, 79% mentioned liquidity factors and 58% cited legal documentation with a limited number of counterparties as a significant factor.


Firms hoping to achieve certification of their existing derivatives trading venues as SEFs, point out that buy-side firms rarely seek five or more quotes when trading swaps currently.

“Most of the executions we see on our platform are bilateral,” said George Harrington, head of global fixed income trading at Bloomberg, which plans to convert its AllQ platform into a SEF. “A buy-side client typically reviews indicative and firm quotes that are already displayed on our platform and executes with just one counterparty.”

Moreover, Harrington added the reporting of swaps exposures to trade repositories will give the buy-side additional data – over an above quotes that are already publicly displayed – to ensure the are obtaining a fair price for their trade.

“We don’t fully understand how the CFTC will encourage competitive pricing by imposing a minimum on quotes,” said Harrington. “The obligation to seek five quotes will result in a ‘winner’s curse’. The dealer that wins the trade will have to pay more to offset risk because of the market impact that is caused from other market participants being aware of the trade.”

The result will be an eventual widening of spreads for the quotes offered, as dealers seek to price in the added risk,” he added.