The absence of harmonised cross-border rules is just one of a number of problems facing operators and users of swap execution facilities (SEFs) when mandated trading begins, a report from research consultancy Aite has found.
So far, only the UK has formally recognised SEFs, while Europe and Asia lag well behind the US in developing and implementing G-20 post-crisis reforms, which include pushing OTC derivatives markets onto electronic platforms. This may encourage non-US entities to avoid trading on SEFs and US-headquartered firms to direct swaps activity through foreign subsidiaries to maintain bilateral trading in the short term.
The UK has implemented an equivalency agreement with the US recognising SEFs and enabling trading between US and UK participants on SEFs, but Europe is yet to formalise recognisition of SEFs.
SEFs were created in the Dodd-Frank Act and are the US embodiment of G-20 measures to reduce the opacity of OTC derivatives markets by forcing trading onto exchange-like platforms. Rules governing Europe’s SEF equivalent, the organised trading facility, are yet to be finalised but will be created within the region’s MiFID II regulatory framework.
“However necessary these regulatory mandates may be, they are the polar opposites of organic market development and have the potential to drastically disrupt global OTC markets, both in the current transition period and post-implementation,” the report, authored by David Weiss, senior analyst for Aite, states, adding, “SEF success is far from assured at this point.”
SEF implementation could drive global swaps business back towards bilateral trading, albeit for a short period of time, which could disrupt markets, Weiss states.
Uncertainty created by the Commodity Futures Trading Commission’s (CFTC) ‘made available to trade’ (MAT) rule that will act as the de facto mandatory trading deadline and prolonged inaction on the part of the Securities and Exchange Commission, which is responsible for securities-based OTC derivatives, could result in dire outcomes for the global market, he adds.
The MAT rule lets SEFs propose which products are classed as available to trade. Once the CFTC approves MAT applications, the instruments in question must be traded on a SEF instead of bilaterally traded. So far, this has resulted in fears of a ‘race to the bottom’ as SEFs attempting to gain liquidity will make available for trading the most illiquid products.
Weiss adds that the MAT rule has also forced SEFs to choose between protecting customers by not putting forward onerous MAT submissions and losing out to other SEFs willing to trade less-liquid products.
“The SEFs themselves, especially those derived from existing business and platforms, must walk a fine line so as not to alienate their existing customers and prospects, which could diminish overall liquidity on their SEF,” Weiss wrote in the report.