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SEFs Arrive: A New Market Structure Is Born

Swap execution facilities officially started on October 2, 2013, but 2014 is the year when they will really hit their stride.

Challenge: Now that swap execution facilities (SEFs) have gone live, buy- and sell-side firms will focus on transitioning to a new market structure, connectivity, pre-trade credit checks, margin costs and new workflows.

Why It's Important: Trading on the new government-mandated platforms got off to a positive start on Oct. 2, without any major hitches. "The launch of the SEFs is a milestone for the $633 trillion swaps market, in which trades are mainly negotiated via the phone," says Sunil Hirani, CEO of TrueEx LLC. "The transparency, standardization and automation can finally be brought to the marketplace."

There's not really a big-bang approach. It's more of an incremental transition of the marketplace." -- Sunil Hirani, TrueEx

Where The Industry Is Now: About 18 firms registered as SEFs and were granted temporary approval by the Commodity Futures Trading Commission. "Any firm that operates a many-to-many trading platform must be registered as a SEF," explains Jim Rucker, credit and risk officer at MarketAxess, which operates a SEF for credit default swaps. Each SEF has to have an order book and, alongside it, a request-for-quote platform. On Oct. 2, SEFs got off to a slow start. Of the 36 firms surveyed by Tabb Group, 77% said they did not trade swaps on a SEF on day one, 14% said they'd started and 9% conducted test trades. "The buy side are doing some testing, and some have become active with trading, some are waiting for other mandates," says Will Rhode, principal and director of fixed income at TABB Group. Most investors are not using SEFs yet since trading on the platforms won't become mandatory until the CFTC approves the list of specific swaps that each SEF wants to trade. "We do expect a ramp up in volumes in January, February and March," says Rhode.

Focus In 2014: SEF operators will focus on implementing the rules and on-boarding buy-side clients. "We obviously are busy trying to get clients, market markers, FCMs [futures commission merchant] to sign our documents," says MarketAxess's Rucker. While large institutional clients knew this was coming, those who are not ready need to work with the FCMs to determine which clearinghouses they're going to use, and they'll need to select the SEFs they're going to trade through. They also need get used to the new workflow with SEFs on posting margin and collateral to clearinghouses via FCMs. "There's obviously going to be very significant changes in workflows when you go from a bilateral market into a centrally cleared market," says Rucker.

[For learn more about all of the topics that will shape the business technology landscape next year, read: Capital Markets Industry Outlook 2014.]

Industry Leaders: The major players are Bloomberg LP, MarketAxess and Tradeweb Markets. New entrants include Javelin Capital Markets, TrueEx and TeraExchange. "The race has just begun," observes Rhode. Interdealer brokers such as ICAP and GFI "would like to demonstrate to the buy side that they are a source of good liquidity," Rhode says.

Technology: With many more trading venues to pick from, analysts expect to see new tools and data feeds arise. "People are thinking about connectivity to SEFs and CCPs, new sources of market data. Some of them already exist, and more will come," says Kevin McPartland, head of market structure research and advisory at Greenwich Associates. Under CFTC and SEF rules, a clearing member (i.e., FCM) must carry out pre-trade credit checking before the execution. Several vendors offer pre-trade credit hubs, including Traiana CreditLink and MarkitSERV's Credit Hub.

Price Tag: It's going to be more expensive for the buy side to get the type of swaps exposure they want, contends Bob Holland, product manager for fixed income at Linedata. To offset the costs, buy side is likely to turn to big custodians, like State Street, BNY Mellon and Northern Trust, which can provide collateral transformation. "If you don't have enough government bonds, they will run it through their magic machines and make it acceptable," says Holland. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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