Widespread SEF swap market uncertainties takes pressure off potential users, for now.

If corporate treasury staff is wondering whether they should be exploring new swap execution facilities (SEFs) more actively given the new trading platforms’ anticipated liquidity and pricing benefits, they needn’t worry about falling behind the curve, yet. That’s because everyone’s in the spot in terms of engagement.

Research by Celent published earlier in March found that even the largest institutional investors have yet to make full-throttled use of SEFs, despite being prepared to do so. “Usually institutional investors are more advanced in terms of connecting to the financial markets, but they’re still playing a waiting game and haven’t put up the volumes over SEFs that people would have expected,” said Dr. Anshuman Jaswal, author of the research.

Part of the reason, Dr. Jaswal said, is the buyside is still awaiting clearer indications for where the liquidity will end up. Until recently, he added, Celent viewed the smaller, more innovative SEFs such as Javelin Capital Markets and truEX Group, with “interesting and appealing products,” as likely beneficiaries of the new system. Liquidity, however, has instead been drawn to the old-time players—the inter-dealer brokers’ platforms, Bloomberg and to a lesser extent TradeWeb.

Although SEFs went live for trading last fall and swap clearing became mandatory earlier in the year, trading over SEFs only became required in January when regulators approved the first made-available-to-trade (MAT) determinations, which define which swaps must be traded over all the SEFs. Javelin’s and truEX’s MATs were approved first, but they’ve lagged in capturing trading volume.

Not only is it uncertain which SEFs will capture market liquidity, but other derivative markets are jumping in to compete for it as well. Swap futures from CME Group and Eris Exchange have been around little more than a year and provide an alternative somewhere between cleared swaps and exchange-traded futures. Eris, whose Flex product gives more flexibility in choosing terms, reported at the end of February that open interesting in its US dollar interest-rate swap futures topped $10 billion in notional value.

In terms of trading interest-rate swaps over SEFs, Clarus Financial Technology reports overall swap volume dipping from $600 billion at the start of February, to around $330 billion mid-month, and rebounding to about $700 billion by March 3. Nevertheless, only 33 percent of trades were over SEFs.

Dr. Jaswal said Celent’s discussions with buyside firms suggest they view SEF trading volumes to be somewhere between 30 percent and 50 percent below what they anticipated. He added that the more active buyside players are likely make firmer decisions on where and what to trade over the next several months.

“So from that point of view, corporates can take their time before deciding the products they’ll deal in over SEFs and the platforms they’ll commit to,” Dr. Jaswal said.

For the foreseeable, only standardized and liquid swap contracts will trade over SEFs, and corporates can continue to trade the highly customized swaps they typically use bilaterally, through a broker. That may change over time.

“While the regulations are more relaxed for corporates, the idea is for the larger ones to eventually start trading over the new infrastructure,” Dr. Jaswal said. “As the number of new products slowly increases, less standardized ones could move to SEFs, too, if there’s sufficient trading to warrant it.”

To trade over SEFs, corporates can tap brokers to trade on their behalf, and many of the brokers also offer or plan to offer sponsored access allowing customers to initiate trades over SEFs within certain parameters. Corporates actively trading swaps may choose to connect directly to SEFs, although finding best execution would require maintaining connections with all the SEFs trading the relevant swaps.

In most cases corporates will continue to use brokers, and one benefit of the SEF market may be a greater selection of brokers eventually to do business with, and so more competition and presumably lower prices, even in the over-the-counter bilateral swap market.

Dr. Jaswal said new regulations are pushing big banks to more of an agency model, giving regional financial institutions the opportunity to take on a bit more risk and compete for business more effectively than before. That competition may start out over the SEFs, allowing regional banks to build customer relationships with corporates previously outside their traditional business geography that could extend to more opportunities to bid on OTC business.