As the US swaps market began the transition from telephone trading to electronic trading on swap execution facilities (SEFs) this week, a number of issues hung in the balance, including which of the SEFs that have registered with the US Commodity Futures Trading Commission (CFTC) will be successful, how vendors can support firms trading on SEFs, and how pricing can be compared across SEFs.
The CFTC’s final rules on SEFs were set down in August 2013 and requests from firms wanting to register as SEFs followed soon after from those already operating in the swaps trading business and from newcomers keen to get a slice of the action. In January 2014, the CFTC set deadlines for mandatory trading on SEFs, requiring certain interest rate swaps to be traded on SEFs by February 15, 2014 and credit default swaps to be traded on SEFs by February 26, 2014.
Sapient Global Markets is working with buy-side firms that must trade on SEFs and with firms setting up as SEF platforms. Many of the former, it says, have struggled and are struggling to meet the regulatory deadlines and spending considerable sums to achieve the short-term gain of not being fined by the regulator, while the latter are taxed by onerous, but easing, regulatory rule books.
Jim Myers, senior manager, Sapient Global Markets, says: “Everyone is struggling with the move to SEFs. The sell-side less so as it has been looking forward and planning for longer, but the buy-side is less prepared and will struggle for some time as there is little confidence in how the change will play out.”
Sapient Global Markets has been advising buy-side customers on how to meet the SEF deadlines, but also helping them to look ahead at the concept of SEF aggregators. As in other markets, SEF aggregators could solve the problem of firms having to select and connect to many SEFs, instead providing single platforms that compare pricing across SEFs and allow firms to identify best bid and offer prices.
Myers explains: “Many of our clients want an entire picture of the market, which leads to the idea of SEF data aggregation. This needs to be automated and could be done in-house by building interfaces and aggregating data streams from different SEFs, but there are other options.”
An in-house build is likely to be an unwelcome burden for many firms and can be avoided to a certain extent by using trading solutions from vendors including FlexTrade Systems and Ion Trading. These solutions are not – at least, not yet – marketed for SEF aggregation, but their capability to aggregate different prices from all types of markets could lend itself to SEF aggregation.
Paul Gibson, business consultant at Sapient Global Markets, notes another option that could ease the buy-side burden and is not dissimilar to front-end platforms that aggregate data from several exchanges in other markets. He explains: “There is potential for large sell-side firms to offer a service to buy-side clients. The sell-side firms could take all the liquidity on SEF platforms and offer it to the buy-side, providing sponsored access to SEFs without requiring buy-side firms to make difficult legal and technology changes that are required to trade on SEFs. This would be a real value add for buy-side clients and would allow them to look at different SEFs and know they are getting best prices.”
While SEF trading solutions are not yet off-the-shelf products, there are other vendor solutions that support the move of swaps trading to electronic venues. Credit hubs such as CreditLink from Traiana and MarkitServ Credit Centre from Markit can play a part. MarkitServ Credit Centre, for example, is a low latency, centralised pre-trade credit checking platform that connects trading counterparties, execution venues, futures commission merchants and clearing houses. It gives buy-side firms control over their credit lines and allows SEFs to check credit before orders are posted.
Myers says: “Integrating systems to support SEF trading is not a short-term project. A credit hub is a useful service and supports order flow, but it is only one piece of key infrastructure that must be implemented and integrated with multiple systems such as accounts, risk management and clearing systems.”
Looking at SEFs, the number that buy-side firms will be able to trade on is uncertain. In the early days of electronic trading, some SEFs are handling significantly more volume than others, suggesting there will be fall out. To date, 21 SEFs have been registered, but many are niche players, and 13 are in action. Most of the active SEFs with a good following were already in the swaps trading business before the SEF trading mandate came into force. These include Bloomberg, ICAP, MarketAxess and Thomson Reuters. Start-up SEFs are lagging in terms of trade volumes and may withdraw from the market, but there is no doubt that more will emerge and some certainty that a handful of start-ups working in narrow niches may succeed.
Myers explains: “A start-up could apply to the CFTC to be a SEF with a unique ‘available to trade’ swap. If the start-up is approved it could have a product that could only be traded on its SEF platform. This isn’t happening at the moment as CFTC rules would allow other SEFs to list the product, but a SEF could perhaps patent a product and prevent others from listing it.”
As the first phase of SEF trading raises and resolves early issues, a second phase will undoubtedly present more. Gibson concludes: “At the moment, we are advising firms and helping them get ready to meet the SEF trading deadlines. Once firms are up and running, they will want to get orders in as quickly as possible, so the next phase of innovation is likely to include issues around latency.”