Think all uncleared swaps can trade outside SEFs? Think again. End users who assumed that their exemption from central clearing meant that they didn’t have to trade swaps through swap execution facilities, once those went live on October 2, are quickly being disabused.
According to a paper by Karl M. Strait, John S. Servidio and Richard W. Viola of law firm McGuireWoods, the issue boils down to whether the swap will be traded on a multi-to-multi trading system. Under the Commodity Exchange Act, all such systems must be registered as SEFs. Since October 2, SEFs are the only trading platforms available for trading swaps, even uncleared swaps.
“End users may want to use, or continue to use, multi-to-multi platforms for a number of reasons, including ease of execution, increased liquidity, price transparency and/or favorable pricing,” the authors write. “In addition, if an end user cannot, or chooses not to, elect the end-user clearing exception for a swap subject to mandatory clearing, then that swap must be entered on a SEF. While trading swaps on a SEF may have certain advantages over traditional bilateral OTC trading, those advantages are not without additional costs and risks.”
These are largely a function of the onboarding, regulatory and compliance costs of bellowing to a SEF. End users must appoint an authorized administrator and negotiate an SEF participant agreement. As the authors write, “The compliance obligations imposed on end users under a SEF’s rulebook will be more extensive than, and quite different from, the contractual obligations that may have previously applied to their multi-to-multi swaps trading. In addition to trading practices and procedures, the SEF rulebooks address disclosure obligations, minimum financial and financial reporting requirements, disciplinary procedures, books and records requirements, SEF rights of inspection, and so on.”
So the end-user exemption, while reducing the potential cost of central clearing, may leave corporates open to significant compliance costs when it comes to simply trading swaps via SEFs.