Swap execution facilities won’t operate in isolation; rather, they will only be as good as their connections enable them to provide clients with compliant, reliable and speedy trade execution.
The challenge of doing so goes well beyond setting up trading and investing firms to send orders.
“In addition to technical connectivity, process flow and data reporting are critical as SEFs and swap dealers need to have the proper process in place to communicate key information for trade reporting to swap data repositories (SDRs),” said Marisol Collazo, U.S. chief executive for the DTCC Data Repository, a unit of Depository Trust & Clearing Corp. “This is particularly important for permitted transactions, which are swaps not subject to the mandatory trade execution requirement.”
SEFs face significant technical, compliance and operational challenges in connecting to swap dealers, major swap participants, swap data repositories and clearinghouses. While SEFs officially open for business on October 2, the business is very much a work in progress, as evidenced by the Commodity Futures Trading Commission earlier this week extending its deadline to meet certain requirements.
The initiative to move swaps trading from privately negotiated transactions onto centralized facilities has its roots in the financial crisis of 2008-2009, the Dodd-Frank Act of 2010 explicitly mandated the creation of SEFs.
But even with the long lead time, the looming SEF deadlines have resulted in something of a scramble among the buy-side and sell-side market participants who need to be connected. Sources have attributed the market procrastination to several factors, among them the expectation that Republican Mitt Romney would have won the 2012 U.S. presidential election and rolled back Dodd-Frank, and generally constrained resources that have trading and investing firms focusing on day-to-day business rather than development work.
“Everybody’s behind the curve,” said Anthony Buzzi, chief operating officer at New York-based Maritime Capital, which trades interest-rate swaps and credit-default swaps to hedge its portfolio of investment-grade municipal bonds. “Just like there were problems with meeting the June 10 deadline for clearing, there will be problems meeting the October 2 deadline for SEFs.”
“SEFs will help to increase liquidity and transparency in the swaps market in the long run,” Buzzi told Markets Media. “However, the establishment of SEFs is taking too long and lacks an effective plan.”
Last week, industry non-profit FIX Trading Community published guidelines for electronic communication between broker-dealers and the emerging SEFs, pertaining to which clients can trade with which counterparties, what types of trades are permissible, and how trades should be cleared. The guidelines explain how the currently manual process required to transfer details about client relationships and their associated permissions can be carried out in an electronic, automated and standardized manner.
"The new FIX guidelines will help the industry standardize client enablement on electronic derivatives platforms," Justin Peterson, managing director at Tradeweb, said in a release issued by FIX Trading. “We believe market participants will benefit from the increased speed and capacity it will bring for enabling with SEFs in the U.S., but also electronic platforms in Europe and Asia."
The CFTC approved Tradeweb's two SEFs last month.
Pushed Back
Regarding the delayed implementation, the CFTC had received requests from multiple temporarily registered SEFs that it provide time-limited no-action relief for SEFs from swap data reporting obligations provided in Parts 43 and 45 of the Commission’s regulations.
Part 43 requires SEFs to transmit swap transaction and pricing data to an SDR as soon as possible, so the SDR can disseminate data in real time. Part 45 requires SEFs to report swap ‘creation data’, including primary economic term data and confirmation data, as well as swap ‘continuation data’ to SDRs, also as soon as possible.
What’s more, SEFs are required to generate and assign a unique swap identifier, after the execution of the swap and before the reporting of required swap creation data, and transmit the identifier to an SDR.
“Swap dealers will have to report continuation data on these permitted transactions after the trade has been reported by the SEF,” said DTCC’s Collazo. An Oct. 2 compliance date “make(s) it difficult for these issues to be ironed out and end-to-end operational testing to be formed...This could lead to degradation of data quality in the SDRs."
For their part, SEFs say they’ll be ready to roll when the checkered flag comes down. “Establishing connectivity has always been central to our business and operations,” said Christopher McEntee, director of corporate development at IntercontinentalExchange. “We are confident that our customers will have seamless connectivity.”
The CFTC ruled, via Footnote 88 in its final swap core requirements, that permitted transactions (transactions that are not subject to mandatory clearing) must be traded on a SEF along with required transactions (those that are subject to mandatory clearing), as long as the platform on which they’re traded is multi-dealer.
That vastly increases the number of swap transactions, and therefore the complexity, associated with reporting to SDRs and CCPs.
“When the final rule came out, we were surprised to see that the CFTC expected to implement the SEF regime for all permitted transactions, which requires us to implement an infrastructure for many products when our focus had been on a few products,” said Scott Fitzpatrick, executive director of strategy and business development at interdealer broker Tradition, during a Sept. 12 CFTC-sponsored panel discussion. “Footnote 88 has raised serious concerns for the industry.”