Swap Markets Debate Anonymous Trading in SEFs

Challenge: Buy side firms are being asked to disclose their identities in the swaps market during the post-trade process, even though trading is supposed to be anonymous on order books.

Why it's important: The Dodd Frank Act envisioned an all-to-all market with anonymous trading. Swap Execution Facilities (SEFs) are required by law to provide both electronic request for quote (RFQ) and the order books. But the jury is still out on whether institutions want to trade anonymously. Today, clients are mainly using electronic RFQs on Bloomberg, Tradeweb, and other SEFs, so it's not clear that they want to trade anonymously on order books. "If you look at a separate dealer-to-dealer market and dealer-to-customer market, most of the clients tell us they actually get arguably better pricing by virtue of showing who they are to one of their liquidity partners," said Nathan Jenner, chief operating officer of Bloomberg Electronic Trading, during the SEFCON V conference in November. However, speaking on the same panel, Rana Chammaa, executive director of FRC Execution Sales, UBS, contends that clients are "sitting on the sidelines because they [SEF order books] still maintain post-trade order give-up," meaning that names of either counterparty can be disclosed to either side after the trade is executed.

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• Swap Markets Debate Anonymous Trading in SEFs
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Where industry is now: After a slow start, SEF volumes increased by 49% from October 2013 to February of 2014 as SEFs as benchmark swaps were made-available to trade or (MATed) through a self certification process,  which fueled trading on the electronic venues. "The lower volume was due to uncertainty and digestion of rules," observed Sean Bernard, CEO of Tullett Prebon's SEF, at SEFCON V, a swaps industry conference held in New York. There are 24 SEFs "provisionally registered" and through the summer notional trading volumes on SEFs exceeded $1.5 trillion, noted CFTC chairman Timothy Massad in a keynote at the swaps conference. Despite fluctuations in volumes, the past 18 months have led to dramatic change with buy side clients focused on signing up for clearing and onboarding with future commission merchants (FCMs) acting as introducing brokers to SEFs and clearing houses. "For the past year, swap markets has been focusing on RFQ -- check the box -- clearing for products that were made available to trade (MAT), and clearing for non-deliverable forwards (NDFs) in FX (still pending) and swaptions," says Ric Okun, managing director of PIMCO on SEFCON's tech panel. "That brings us to CLOB [central limit order book] trading as the next big hurdle," said Okun.

Focus in 2015:  More SEFs are expected to list Market Agreed Coupon (MAC) swaps, which could push more buy-side trading onto anonymous order books. On Dec. 8, Javelin SEF launched an anonymous central limit order book for MAC swaps, following moves by TrueEx and GFI Group, which were first. Tradeweb has also been trading MAC swaps on its RFQ offering since 2014. Some say there is a need for MAC swaps before anonymous SEF trading can take off. "I think the buy side likes the concept of standardized products because they also like the concept of clearing and anonymity. They also felt the pull back from dealers in terms of liquidity that they were willing to provide," said John Dobbs, managing director at Credit Suisse, speaking on the SEF tech panel. "The question then becomes which CLOBs will be viable and who's offering CLOBs," Dobbs told conference attendees. So far, SEF startups have been the most aggressive in offering CLOBs. Meanwhile, the prevailing view is that RFQ trading will exist alongside order book trading into the future.

Connectivity: With 24 SEFs in the market, buy side firms can't connect to everyone, and there is a cost for dealers to connect to all the SEFs. Currently liquidity is dispersed among six or seven SEFs, said sell side sources. Next year, the buy side will continue to decide on connectivity and which SEFs have the liquidity. They can choose to connect with single SEFs or an aggregator to access liquidity from a multitude of SEFs. "The value of our platform is insulating them from the legal and regulatory aspects if they were going to connected to multiple SEFs," said Chammaa of UBS. Acting as an introducing broker, UBS has signed up 100 clients for NEO, an aggregation platform that provides access up to 10 SEFs.  Some large buy-side firms are still weighing that decision. "We want to be SEF agnostic. We obviously want to go wherever there is liquidity. We've seen some exciting things in the aggregation platforms, but nothing has taken off yet, or gone to the moon," said PIMCO's Okun.

Regulatory View: CFTC chairman Timothy Massad said the agency would review the so-called "name give-up" practice in the swaps market that some investors claimed has been discovering trading, according to a Wall Street Journal story. Though trades are negotiated anonymously between parties, names are released while confirming trades over the phone or through affirmation platforms.

"Establishing the new platforms, creating the new infrastructure, testing and refining to make sure things work smoothley takes time and resources. The increase in SEF trading tell the benefits of SEF activity are being realized." — Timothy Massad, Commodity Futures Trading Commission

Obstacles: One of the hurdles to growth of anonymous order book trading is that bespoke, customized swaps create a lot of line items at the clearinghouses, requiring higher margin payments. "With fixed dates and coupons, MAC swaps by design are standardized instruments that promote enhanced liquidity and automatic line-item reduction," said Michael Koegler, managing director of Javelin. [Javelin also filed a request with the CFTC for margin relief on MAC and IMM swaps, which it argues are economically equivalent to futures swaps on Eris Futures Exchange and CME.] Even if MAC swaps are listed, operational issues exist. "The challenges persist in the CLOB type of structure -- the line items, that even if you trade the MAC swaps, being able to aggregate that because you may be getting multiple fills into multiple SEFs and being able to put that into one line, from a books and records perspective," said Credit Suisse's Dobbs.

Several panelists also cited the need for technical standards. "We would definitely appreciate a more standard approach to connectivity, to integration and to standardization," said Maged Hassan, global head of Fixed Income Electronic Trading Technology at Morgan Stanley, who spoke on the SEFCON V tech panel. "Morgan Stanley is part of several technical standards working groups that are trying to make the integration costs as cheap as possible," he says. Another issue cited is the lack of consistent symbology that extends across every SEF. Unlike equities where IBM stock is the same on each exchange, swaps can have different symbols across SEFs. "That is a substantial problem to solve today after everyone is live," said Hassan.

Technology providers: There are many technology providers for swaps trading, including individual SEFs like Bloomberg, MarketAxess, Tradeweb, TrueEx, and more. Third-party tech providers include Droit, Markit, SwapsHub, Triana, and more.