New ways of attracting buy-side participation on swap execution facilities (SEFs) are emerging after a year of relatively slow progress for the US electronic trading platforms.
SEFs launched in October last year in line with regulatory mandates for OTC swaps to be executed electronically on the venues and then centrally cleared.
Following their introduction, 50% of interest rate swaps and 70% of credit default swaps are now traded on SEFs, though buy-side uptake of the new form of trading has been slow.
“The access aspect for the buy-side is a bit prohibited, they want to trade the simplest way possible with the most options as possible so onboarding onto SEFs is not something you want to consider,” said Paul Gibson, business consultant at Sapient Global Markets.
“All the legal, technological and operational stuff they have to do to onboard and trade on a SEF is not really worth it.”
With only major buy-side firms realistically able to sign up to multiple SEFs, new ways of bringing their business towards the platforms have come to the fore.
One of the models touted has been SEF aggregation, where dealers are allowing buy-side firms to see prices across central limit order books (CLOBs). The issue here is that the slow uptake of CLOBs from the buy-side has been one of the major hindrances in the venues growing in the first instance.
For the buy-side to migrate over to SEFs there needs be liquidity on the CLOBs. A way some futures commission merchants (FCMs) are conquering this is by exploring sponsored access models.
Through this service, a buy-side firm would be able to trade directly on a SEF through an FCM’s membership, therefore removing the barrier of onboarding onto multiple SEFs.
“FCMs are looking to bring some of the execution models we have seen successfully utilised in the exchange-traded derivatives world over to SEFs,” explained Jim Myers, senior manager, business consulting trading and risk management, Sapient Global Markets.
“Aggregators are out there whether it be Neo, SwapsHub or private labels, are offering functionality where you connect to one entity and that then opens up the entire universe of SEFs to you and you can trade on any of them. In some cases the entity providing the service is the one that signs on and acts as an intermediary between the SEFs and the buy-side.”
Myers added that some FCMs are also considering ‘On behalf of’ trading where introducing brokers would execute the trades and hold the margin for trading on the account.
With these initiatives and more ‘made available to trade’ mandates on the horizon, SEF volumes are likely to rise, however the volume is unlikely to mirror the activity before trading and clearing mandates were introduced.
Part of the volumes are likely to have moved to either non-standardised OTC products or exchange-traded derivatives.
The SEF space is being dominated by the major players who entered the space in February, with a handful of interdealer brokers and existing market heavyweights boasting the most volume.
One of those experiencing the most volume is Bloomberg, which is leading the way in terms of credit default swaps.
“What is really driving activity is that you have the safety of clearing and transparency you get with the SDR [swap data repository] reporting, which is attracting people who left the derivatives markets years ago or people who have never been involved,” George Harrington, global head of fixed income trading at Bloomberg.
“From the buy side’s perspective, transparency is the biggest deal. Clearing has been out there for a year and a half now and people have an idea of where the prices are by looking at the SDR. It has really driven the buy-side towards the trading platforms. Electronic trading is becoming more ingrained in the market, and there’s not as much fear as there used to be.”
Harrington added that Bloomberg had seen a lot more CLOB activity over the past six weeks, and believes the buy-side is gradually starting to adopt the use of SEFs.
A recent report from consultancy Greenwich Associates found that 23% of investors were using SEFs in 2013, with the number rising to 41% in 2014. According to the survey another 20% said they plan to start trading electronically in the next 12 months.
The uptake will certainly begin to increase in the coming years, with foreign exchange mandates soon to push non-deliverable forwards onto the platforms.
Some of the smaller SEFs outside the big seven have found it difficult to gain traction and according to Myers they will need to act soon to keep up with the market leaders.
"The established platforms are still the ones that are able to exhibit consistent and solid market share, the upstarts have not really made a dent yet," he added.
“They are trying to diversify their business models to try and be relevant, whether it be through offering compression services or anything else they can think of in the space because they are just not getting that transactional volume on their platforms.
“I think the new entrants are either going to go out of business of be forced to innovate and draw some volume, and they are trying to innovate right now so it will be interesting to see how that will play out.”