Following the Commodity Futures Trading Commissions (CFTC) proposed rules yesterday on the swaps clearing, it is hoped that the securities industry can now focus more on the trading landscape, and specifically, what might constitute a Swap Execution Facility (SEF).
So far the industry has been hazy on what these facilities are, or rather, who they will be. For a year, confusion has reigned on the subject as it dwindles in focus behind clearing, with the appointment yesterday of the DTCC and SWIFT as suppliers of legal entity identifiers to registered entities and swap counterparties for CFTC data reporting under the Dodd-Frank Act (DFA). Swaps subject to this clearing requirement may additionally need to trade either on exchange or via a SEF.
Thankfully, the CFTCs July 10 definition on what constitutes a swap and which swaps and swap dealers are subject to and exempt from the DFA rules include central clearing as well as yesterday’s proposals, have added further clarity on clearing.
In the absence of certainty about how these swaps should be traded under the new regulatory framework, capital markets intelligence firm GreySpark has published some research on the business case for introducing SEFs (one of the primary mandates in DFA), identifying who they think will be the main SEFs providers. The report looks at the current and planned landscape in a cleared market, assessing the SEF venues competing to execute cleared swaps and the likely market structure and evolution across market classes. The report analyses the offerings of 52 potential SEFs, with the focus on the top 12 (based on product coverage, volumes and current market share/positioning).
GreySpark identifies the three categories of SEFs, which are required to increase transparency and minimize bilateral exposures between swap counterparties as all trades executed on a SEF will need to be cleared via a central clearing house.
The first category of SEF GreySparks identifies are the large, multi-asset venues, providing broad coverage across eligible products and offering various methods of execution (for example Reuters). These venues will ultimately be targeting both the interdealer or D2D market (primarily through a central limit order book, or CLOB) but also the brokerage or D2C market with a range of quote-based trading options. Given their reach, says GreySpark, these venues are likely to be the biggest winners from the SEFs regulation. The second most prominent class of SEF will be those focusing on a single or limited market, whether this is a particular asset class or a focus on a particular style of execution (for example Creditex). These SEFs will offer asset class specific features such as volume clearing and portfolio compression for credit, advanced auction features for rates and specialist RFQ functionality to cater for the complexity of some FX options that will be SEF eligible. Finally there are the many potential SEFs that are smaller in size but without the ease of connectivity or access to deep liquidity offered by many of the Tier 1 and Tier II venues.
The 52 SEFs identified are 360T, BGC Partners, Bloomberg, Bondvision, Cantor, CBOE, CME (ClearPort/ NYMEX, Creditex, Currenex, Digitial Vega, eDeriv, Eris Exchange, Exane , FFastFill, FlexTrade, FX Connect, FXall , FX Bridge, GFI, GMI, Hotspot FX, ICAP, ICE (USA), Integral, Javelin, Kepler, Key Capital, LCH.Clearnet, Louis Capital Market, Mariana Group, Kyte Group, MarketAxess, Newedge, Nodal Exchange, ODEX Enterprise, OTCex Group, Parity Energy, Phoenix, Portware, Qantex, State Street, Sunrise Broker, SurfaceExchange, Thompson Reuters, Tradeweb, Tradition, Trayport, trueSEF, TruMarx, Tullett Prebon, Vantage Capital Markets and Vyapar.
The following vendors represent the top 12 proposed SEFs which GreySpark have identified based on product coverage, volumes, current market share and positioning: BGC Partners, Bloomberg, Creditex, FX All, GFI Group, iCAP, Javelin, MarketAxess, Tradition, Tradeweb, Tullett Prebon and
State Street.
There will be further consolidation among the 52 providers, says Bradley Wood, partner at GreySpark. Some players will try to consolidate but there will continue to be fragmentation as the market for SEFs broadens.”
The GreySpark also takes into account a number of emerging trends. Firstly, the swaps market has traditionally operated a two-tiered structure with D2D markets operating in the wholesale space and brokers making markets in the D2C space. With the advent of SEFs (and OTFs in Europe), the market structure will likely begin to move towards the model currently used in equities and exchange traded futures and options for most asset classes with the notable exception of FX, says GreySpark. This is evidence by the fact that Many SEFs are planning to support a CLOB market structure from inception, and that traditional minority D2C/RFQ focused venues are looking, additionally to propose a CLOB model.
At the time of writing the research, the full and exhaustive list of SEF-eligible products had not been determined and there are some further clarifications required before the list is considered final. However, the industry participants that the regulation will cover interest rate swaps, credit (single name credit default swaps and indexed credit default swaps), FX (FX spot, forward and swaps, FX options, non-deliverable forwards and cross-currency swaps), equities (equity swaps and equity options) and commodities (cash settled contracts and physically settled forwards)
Further to the trend of SEFs opting for a broader coverage is that a number of venues are planning to offer an auction capability, particularly within the D2D space.
The CFTC has also mandated the use of a Legal Entity Identifier for all SEF-executed trades in order to be able to effectively monitor, group and roll up reporting so as to provide greater transparency. Once the swap has been executed any event needs to be captured and sent to a swap data repository.
GreySpark also notes that many facilities will support FPML and UPI (product ID) language and their pre-trade risk capabilities will include circuit breaks, fat finger control. Additionally, any CCP would be able to provide real time credit info back up to the SEF. In terms of CCPs, GreySpark anticipates that CME and LCH would have the highest adoption rate of SEFs trades. In terms of post trade affirmation, on which the SEFs depend, the research firm anticipates companies such as MarkitWire providing a significant amount of middle ware trade affirmation as one pipe into MarkitWire gives access to six CCPs.
In addition, GreySpark believes it makes sense for swaps data repositories such as DTCC, ICE and CME to be used for clearing and reporting functions.
GreySpark anticipates that the sell side and buy side will be able to connect to SEFs via D2D or D2C. Buy side entities including funds, asset managers, large corporates will be able to connect directly to a SEF or it could connect via a futures clearing merchant (FCM) or a full clearing member. The FCM would pass the margin call onto its client.
How SEFs would be paid is another grey area. The expectation is that if it is order based fees might follow the maker-taker model. If it is quote based, through Bloomberg, for example, the pricing would likely be based on user fees.
– Janet Du Chenne