US market operators are preparing for new rules that will reform trading of credit default swaps indices, including MarketAxess, which is seeking temporary exemption from swap execution facility (SEF) registration due to the associated cost burden.
While US market participants are still awaiting for the Commodity Trading Futures Commission (CFTC) to agree on SEF rules before firms can apply for registration, MarketAxess is seeking a conditional exemption from registration until its venue accounts for 20% of the daily notional transaction volume of all CDS index trades.
SEFs are new venues for trading OTC derivatives prescribed in the Dodd-Frank Act. Reforms to the swaps market also contained in Dodd-Frank require OTC derivatives to be centrally cleared and reported to newly created data repositories. Some types of market participant began reporting interest rate swaps and CDS trades yesterday, as per the new rules.
MarketAxess said its budget for registering as a SEF would exceed US$5 million in its first year of operation, with an annual cost of US$1 million thereafter to operate as a self-regulatory organisation. As mandated under Dodd-Frank, the CFTC has the power to grant venue operators as exempt SEFs.
Part of the rationale behind MarketAxess’ decision lies with the size of the index CDS market, which only has around 6,000 trades a day globally, half of which occur in the US.
The firm added it trades over 4,000 corporate bonds per day on its platform, which is overseen by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) and stated it met rules on corporate governance and disclosure requirements as per its obligations as a listed company.
In addition to maintaining SEC and FINRA broker membership, MarketAxess’ exemption request includes conditions pertaining to swap data reporting, pre-trade transparency, record-keeping, conflict of interest management and a limitation of trading on its exempt platform to index CDSs trading.
“MarketAxess believes that granting this exemption is in line with the overall goal of the Dodd-Frank Act – to bring increased transparency and competition to swaps trading,” read a statement from MarketAxess. “If the SEF entry barriers remain unnecessarily high, competition will be stifled, and transparency and efficiency in the CDS markets will be reduced.”
The CFTC is expected to propose its final rules for SEFs within the next two months, having initially been expected in February.
ICE to launch CDS index futures
Meanwhile, IntercontinentalExchange (ICE) plans to launch futures based on credit default swap indices from May, offering investors a listed alternative to swaps.
The contracts will be based on Markit’s CDX and iTraxx indices and require approval from the CFTC. Currently, investors that want to trade CDS index derivatives typically do so through the swaps market.
Although ICE’s CDS index futures can offer a similar exposure to some swaps trades, they are not economic equivalents like the CME Group’s deliverable interest rate swap futures, which are designed to exactly replicate existing OTC derivative contracts.
“These new products were developed with customers to meet their credit risk management needs. Our new credit index futures contracts provide customers with the benefits of the fully-regulated futures markets while also serving a complementary role to the existing credit index swaps market,” said Thomas Farley, senior vice president, financial markets, ICE. “We are pleased to work with Markit and to use their transparent, rules-based indices to develop these contracts.”
The new contracts will allow investors and credit market participants to access and hedge the corporate credit market and will be listed twice a year for expiration on the dates the new series begins trading in the swaps market. At expiration, any open contracts will be cash-settled based on the Markit-ICE end of day settlement price of the five-year swap. The contracts will be cleared at ICE Clear US and the exchange plans to introduce further credit index futures based on market demand.