The effects of mandatory trading rules for swap execution facilities (SEFs) could potentially alter the course many expected SEFs to follow, but bilateral OTC derivatives trading will remain a constant for the buy-side in particular.
What will be the likely impact of the ‘made available to trade’ rule and mandatory trading on SEFs?
This impact of ‘made available to trade’ (MAT) is unclear, but experts fear it could alter how the buy-side engages with SEFs. Essentially, the MAT rule stipulates that market participants must use SEFs to trade an OTC derivative instrument once it is offered across any SEF, as opposed to trading it bilaterally. This rule, designed the by Commodity Futures Trading Commission (CFTC) to encourage SEF usage and volumes, was initially widely criticised by the industry.
Two SEF operators – Javelin and trueEx – have submitted rival MAT filings. One, from trueEx, seeks to keep the ecosystem of instruments small, and concentrated in highly liquid swaps with a view to extending this with industry support in the future. In Javelin’s proposal, a wider range of instruments would be offered to hasten the transition to SEF-based swaps trading – even somewhat exotic, less-liquid instruments.
The CFTC has a thirty-day comment period for both the Javelin and trueEx filings, which will expire in the next three weeks. After this, a three month period will begin until whichever MAT rule selected comes into force – most likely around March next year.
Will the bilateral market enjoy continued volumes, or will the successful launch of SEF trading attract more instruments onto order books?
It is widely anticipated that traditional, bilateral OTC derivatives trading will continue to attract healthy volumes, as many instruments simply aren’t suited to an order book model, due to being bespoke instruments created by banks to fulfill specific needs for specific participants. However, the initial volumes apparent on SEFs since trading began on 2 October shows the market has a willingness to engage as regulators hoped on these platforms to trade instruments vital to the risk management needs of the market.
In its CFTC filing, trueEx included a survey (conducted by itself) of a group of market participants including the buy-side, clearing firms and market makers, which found around 55% of respondents would support electronic trading in the most standard rates traded with tenors ranging from one to 30 years. However, only 20% wanted no interest rate swap products designated under the MAT rules, and around 8% supported MAT in all instruments with custom start and end dates from one to 40 years. This latter figure suggests the market should – and will – look to keep SEFs concentrated on the most liquid instruments.
Has the competitive landscape of SEFs changed in the opening weeks of trading?
So far, inter-dealer brokers have performed well, and Bloomberg – which has pursued an aggressive policy in getting its SEF up and running – have attracted strong initial volumes. A view that the number of SEFs will contract from the nearly 20 that have gained temporary authorisation from the CFTC to around eight or nine is one widely held by senior executives at a number of SEF operators.
This will likely occur alongside an expected specialisation, as markets that gain a foothold in one asset class – rates of credit for instance – will flourish. The Bloomberg approach, to attract volumes across a range of instruments, has also shown promise for the few first few weeks of live SEF trading, which suggests exceptions to this rule may exist, and continue to attract flow.