Two rival swap execution facilities’ (SEFs) applications to mandate certain interest rate swaps under the Commodity Futures Trading Commission’s (CFTC) made available to trade (MAT) rule could have severe implications for liqudity.
Javelin SEF and a SEF operated by trueEX have filed separate MAT applications to the CFTC – one looking to introduce SEF trading across the broad spectrum of IRS products and the other limiting activity to the most commonly traded rates.
The MAT rule is designed to propel the shift from bilateral swaps trading to centrally cleared, order book execution by requiring participants to trade a swap on a SEF if any SEF offers that instrument. Critics believe this rule will cause SEFs to offer trading in a wide range of instruments including less-liquid, exotic instruments, for which SEF trading would be inappropriate.
In a statement, Javelin SEF said mandatory swap execution on SEFs was critical to promoting pre-trade transparency, market liquidity and competition in the swaps market, with James Cawley, CEO of Javelin Capital Markets, adding “this is the natural next step for a derivatives market that already enjoys trade reporting and broad clearing. Javelin has gone first—we expect others to follow.”
But, support for Javelin’s approach may be limited.
A survey accompanying trueEx’s MAT proposal to the CFTC – which calls for the rule to be applied to the most traded dollar-denominated IRS instruments – found around 55% of industry respondents would support electronic trading in the most standard rates traded with tenors ranging from one-30 years.
The survey, which included responses from buy-siders, clearing firms and market makers, also found 20% wanted no IRS products designated under the MAT rules, with around 8% supporting MAT in all instruments with custom start and end dates from one to 40 years.
“Until now, the MAT rule has been discussed as a theoretical construct,” Sunil Hirani, CEO of trueEX told theTRADEnews.com. “But, now the clock is ticking and the way the buy-side trades swaps is going to change, one way or the other.”
Hirani urged asset managers to comment on both the Javelin and trueEx MAT submissions via the CFTC website in the thirty-day comment period from 18 October. He didn’t rule out trueEx pushing for a wider net of IRS trades for its SEF in the future, but said the industry must pursue a step-by-step process beginning with highly liquid instruments.
“If you make every instrument tradable, many simply won’t have adequate depth of liquidity, so it’s much better for the market to pursue a phased-in approach,” he said. “It is not prudent to have strategy – spreads, switches and invoice spreads – and portfolio trades under the MAT rule.”
Added pressure
The MAT rule issue arises as SEFs and their clients prepare for the pre-trade credit checking deadline of 1 November designed to create clearing certainty before execution. This will require SEFs to organise extensive connectivity with counterparties and sign users up to new legal agreements.
CFTC commissioner Scott O’Malia last week denounced the Commission’s oversight of the swaps market, and SEFs specifically. In a speech last Thursday to the Edison Electric Institute CFTC Compliance Forum, O’Malia said the pre-trade credit checks initially designed to begin when SEF trading started on 2 October may be pushed back past the current 1 November deadline.
“We are just two weeks away from this new deadline and it is clear that not all SEFs, FCMs, credit hubs and customers are fully interconnected,” he said. “Without end-to-end fully tested connectivity, I suspect trades will continue to be done over the phone – stalling limit order book trading.”