Swap Execution Facility

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Swap Execution Facilities, or SEFs, were given life by the Dodd-Frank Financial Reform Bill, which requires over-the-counter (OTC) swaps to be cleared and traded on this new type of regulated platform.[1][2] According to Dodd-Frank, any swap that is "made available to trade" must do so on a designated contract market (DCM) or a swap execution facility.[3][4]

The CFTC finalized several execution rules at an open meeting May 16, 2013. The finalized rules include:

  • Core Principles and Other Requirements for Swap Execution Facilities;
  • The "made available to trade" provision; and
  • Block trade rules.

For more information on the rules, view the SEF page in MarketsReformWiki.

Contents

Background

The U.S. Commodity Futures Trading Commission (CFTC) has been given the responsibility to monitor swap execution facilities; the SEC has jurisdiction over security-based SEFs.[5]

Regulations were required to be finalized by July 15, 2011. However, several market participants, including the National Futures Association, requested delays in the implementation of swap execution facilities changes, arguing the current time line for changes was too ambitious. The NFA argued that time needed to be dedicated to immediately designing and testing new systems for each swap execution facility that contracted with NFA.[6]

On Dec. 5, 2011, the CFTC proposed a rule that would require the SEF or DCM to submit a determination regarding the availability of a swap for trading to the commission for review, taking into consideration eight factors such as size, liquidity, and the width of the bid/ask spread.[7] For more information, visit the MarketsReformWiki page on the proposed rule.

In March of 2011, ISDA published a paper focused on SEFs which concluded that SEFs may play a positive role in the OTC derivatives market. They may strengthen the infrastructure of the market, help prevent insider trading and other market abuse as well as increase transparency and access to markets for smaller participants.[8]

In September 2012, the U.S. District Court for the District of Columbia vacated a Dodd-Frank rule making related to position limits, concluding that the CFTC failed to follow Congressional intent in implementing its rule. After discussion, debate, revisions, and public consideration, the CFTC plans to adopt a final rule implementing SEF core principles and other requirements. [9]

SEFCON

SEFCON is an annual conference sponsored by the Wholesale Markets Brokers' Association Americas Inc., an industry advocacy group made up of five leading inter-dealer brokers. [10] The conference brings together regulators, legislators, lawyers, swaps professionals and other market participants to discuss key issues related to swap execution facilities ("SEFs"), a new financial transaction entity created by the Dodd-Frank Act. The first conference was held in October 2010, three months after Dodd-Frank was enacted.

At SEFCON III, held in November 2012, John Lothian News conducted interviews with key members of the WMBA. These videos can be found here on John Lothian News

At SEFCON IV, held in November 2013, John Lothian News interviewed several participants and put together a three-part series on the state of SEFs. Part I, Regulation, was published January 17, 2014.

Open for Business: SEFs Navigate the New Regulatory Environment

Though the final rules are out, the industry is still working on a few lingering issues such as new staff guidance and no-action letters on certain aspects of the rules. Also, as the CFTC begins making classes of swaps “available to trade” and subjecting them to mandatory execution on SEFs, the industry is expected to quickly adjust and comply.

List of SEFs

The SEF rules were approved by the CFTC on May 16, 2013, and became effective August 5, 2013. The commission has begun accepting registrations from firms to become SEFs. As of January 17, 2014, 22 firms have applied:[11]

  • 360T - 360 Trading Networks, Inc. was granted temporary registration as of September 24, 2013.
  • BGC Partners - BGC Derivatives Markets was granted temporary registration as of September 19, 2013
  • Bloomberg - Bloomberg SEF LLC was granted temporary registration as of July 30, 2013.
  • CME Group -was granted temporary registration as of November 4, 2013.
  • EOX Exchange- EOX Exchange LLC- registration pending.
  • GAIN Capital Group - GTX SEF - registration pending.
  • GFI Group - GFI Swaps Exchange LLC was granted temporary registration as of September 13, 2013.
  • IntercontinentalExchange - ICE Swap Trade LLC was granted temporary registration as of September 20, 2013.
  • ICAP - ICAP SEF (US) LLC, was granted temporary registration as of September 27, 2013.
  • Integral Development Corp. - INFX SEF Inc. was granted temporary registration as of September 24, 2013.
  • Javelin Capital Markets - Javelin SEF LLC was granted temporary registration as of September 19, 2013.
  • LatAm SEF, LLC was granted temporary registration as of November 18, 2013.
  • MarketAxess Holdings - MarketAxess SEF Corporation was granted temporary registration as of September 13, 2013.
  • State Street - SwapEx LLC was granted temporary registration as of September 13, 2013.
  • SuperDerivatives - SDX Trading LLC - registration pending.
  • SwapEx LLC - StateStreet's SwapEx LLC was granted temporary registration as of September 13, 2013.
  • TeraExchange - TeraExchange LLC was granted temporary registration as of September 19, 2013.
  • Thomson Reuters Thomson Reuters SEF was granted temporary registration as of September 27, 2013.
  • Tradeweb - DW SEF LLC (cash-settled interest rate swaps) and TW SEF LLC (cash-settled interest rate swaps and credit default index swaps) were both granted temporary registration as of September 6, 2013.
  • TrueEX - trueEX LLC was granted temporary registration as of September 20, 2013.
  • Tradition - Tradition SEF, Inc. was granted temporary registration as of September 25, 2013.
  • Tullett Prebon - tpSEF Inc. was granted temporary registration as of September 25, 2013.


Many of the companies had urged the CFTC not to define a SEF too much like a traditional exchange, which has an "open order book" model that publicly lists bids and offers. SEFs should be treated differently, they said, because swaps were generally less frequently traded than futures contracts and a certain degree of anonymity was required to ensure that liquidity in the swap market is preserved.[12]

When the final rules were issued in June 2013, registration as a SEF required a minimum trade functionality, as defined by having an "order book", and offer "impartial access" to its markets, and any transaction not qualifying as a block trade must wither trade on the order book or on a request-for-quote (RFQ) system. For more information, visit the SEF final rule page in MarketsReformWiki.

From Early Tests and Trials to Fully Functioning SEFs

In November of 2010, online derivatives marketplace Tradeweb facilitated execution of the first fully electronic, dealer-to-customer interest-rate swap that was processed by a central clearinghouse.[13]

In February of 2011, U.S. dollar-denominated swap transactions were executed on the Tradeweb institutional multi-dealer-to-client platform[14] Then, in March of 2011, six firms completed multi-product trades on the MarketAxess execution platform, with J.P. Morgan acting as counterparty and clearer. The transactions included single-name CDS and credit index trades. Some trades were cleared; others were intermediated, or remained bilateral.[15]

In September 2013, just before the October 2 compliance date for SEFs, MarketAxess completed the first live trade CDS trade with pre-trade credit checks, using Traiana's CreditLink platform. Under SEF rules, trades may not be completed unless credit between the parties involved in the trade is available. CreditLink acts as a centralized hub that monitors credit availability across venues and allows for real-time pre-trade credit checks.[16]

The CFTC made its first determinations on January 16, 2014 of which classes and tenors of swaps will be "made available to trade," subjecting them to the mandatory execution requirements beginning on February 15, 2014 the date at which the first swaps will be subject to the execution requirements.[17] For more information on the "made available to trade" provisions, including a summary table of specific swap products are affected, visit the MarketsReformWiki page HERE.

References

  1. ICE to register as swaps trading platform, CEO says. Reuters.
  2. SEF 101: Deconstructing the Swap Execution Facility. Deriv Alert.org.
  3. Q+A-What’s at stake for swap-execution facilities?. Reuters.
  4. J.P. Morgan Clears the Air on Derivatives. WSJ.com.
  5. Swap Trading Systems Should Be Broadest Possible, ISDA Says. Bloomberg.
  6. NFA Calls For Swap Execution Delays. GFS News.
  7. Process for a Designated Contract Market or Swap Execution Facility to Make a Swap Available to Trade under Section 2(h)(8) of the Commodity Exchange Act. CFTC.
  8. Swap Execution Facilities. ISDA.
  9. Five issues to watch Swap Execution Facility Rule Making. Bloomberg.
  10. About Us. WMBA Americas.
  11. Trading Organizations - Swap Execution Facilities (SEF). CFTC.
  12. CFTC unveils new oversight regime for swap trading platforms. Dow Jones.
  13. Tradeweb Delivers Milestone in Electronic Swaps Trade. WSJ.com.
  14. Press Release. Tradeweb.
  15. Press Release. PR Newswire.
  16. MarketAxess SEF and Traiana Complete First Live Trade With Pre-Trade Credit Checks. CNBC.
  17. CFTC Certifies Javelin’s MAT Submission. Waters Technology.
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