Market participants have welcomed new rules proposed by the Commodity Futures Trading Commission (CFTC), the US derivatives regulator, for exchange trading of over-the-counter (OTC) derivatives.
Following an open meeting on 16 December, the CFTC has laid out the core principles and other requirements for swap execution facilities (SEFs), a new type of trading venue specifically designed for executing derivatives transactions currently executed bilaterally.
The CFTC and the Securities and Exchange Commission, the US's securities watchdog, are currently in the process of developing rules for exchange trading, clearing and data collection of OTC derivatives under the powers handed to them by the Dodd-Frank Act, signed into law in July.
At the meeting, the CFTC gave the go-ahead for liquid OTC contracts to be traded on electronic platforms with an order book functionality similar to exchanges. It also approved use of the request-for-quote (RFQ) model on swap execution facilities.
“We applaud the CFTC for proposing these definitions for the trading of derivatives, and believe that they will increase transparency and create more efficient markets for end users,” commented Lee Olesky, CEO at Tradeweb, an OTC multi-asset class market operator. “Combined with the clearing mandate, this move to electronic trading will ultimately lead to reduced systemic risk in the derivatives market.” Tradeweb intends to register as a SEF.
However, the CFTC has not specified which types of derivatives should be traded on SEFs or on exchange-like venues, instead leaving this to be decided by market practice. In theory, RFQ and order book models could also be made to co-exist.
Some market participants have welcomed the revision of initial plans for a many-to-many RFQ approach on SEFs. Following the meeting, market participants that use the RFQ function on SEFs, which are likely to be used for the more bespoke OTC derivatives trades, will be required to obtain quotes from at least five market participants. The quotes received will also be commingled with quotes from resting orders in an order book, but it is unclear whether order book functionality for RFQ platforms will be mandated. “The protocol for SEF operation is not as transparent as initially indicated, in terms of participants being able to source quotes that would be visible to the whole market, which is positive,” a sell-side source said.
RFQ platforms such as Bloomberg's SwapTrader or Tradeweb generally restrict quotes to three dealers at the moment. For the time being, it appears that single-bank platforms will not be able to trade OTC derivatives that migrate to exchange-traded models under Dodd-Frank.
Market participants will also be able to stipulate whether a quote request is ”firm' or ”indicative', giving them the opportunity to minimise the risk of signalling their trading intentions to the market.