If swap execution facilities (SEFs) want to see more institutional trading volume, they will need to raise their liquidity and improve front-end integration, according to PIMCO's executive vice president and senior operations manager, Cynthia Meyn.
The current 80,000 swap symbols, which trade across the 24 SEFs registered with the US Commodity Futures and Trading Commission (CFTC), shows how thin the liquidity on SEFs are for the buy-side, said Meyn during this week’s SIFMA Tech conference in midtown Manhattan. “There is not enough liquidity to provide the commoditised market for which an electronic request-for quote (RFQ) system would be suited.”
Unlike the highly liquid cash equities markets, which have trading algorithms like volume-weighted average price (VWAP) that help minimise an order’s footprint on the market, that technology doesn’t exist yet in the SEF world, she added.
Liquidity also quickly drops after passing the top 10 or 20 liquid names from the ISDA reports. There might be volume on a 10-year CDX name, when a trader is looking for a three- or five-year contract.
“If you go to a SEF and put in a request for quote, it is like saying ‘I’m about to do the following,’” Meyn explained. “It is like standing at the plate and letting people know you are going to hit it to left field. All of the dealers move to left field and if I’m going to buy a lot, the price suddenly goes higher. If I’m going to sell a lot, the price suddenly goes lower.”
This is not to say that PIMCO does not execute listed swap trades on SEFs. It does, but it is highly selective on its choices of SEFs.
“In terms of which SEFs we choose to use, we use the ones with the greater liquidity or which are better integrated with out front end,” she said.
Before the CFTC-mandated “made available for trade” went into effect in February 2014, integrating systems for bilateral trades was relatively easy, according to Meyn. “We would type something once and it would be matched with the dealer over an electronic matching platform to make sure that we had the same economic terms and conditions. Then the same front end would flow that data downstream to tell the custodian what was happening.”
Once a buy-side firm trades on a SEF and receives its confirmed order, it needs to give up all of its allocation, she said. Firms then need to key in its account numbers, unless it has built a software layer to do this. If it has, sending the swap’s terms and condition would lead to a pretty fat message, which could make the firm want to build another software layer to handle this.
“How do I get all of that information down into my record keeping systems where I need to notify custodians and move money on the back of that swap,” she asked. “There needs to be another message coming into our front-end system that writes internal tickets on these trades or they are re-keyed.”