Swap end users hesitating to connect to new swap execution facilities (SEFs) may be concerned they’re missing an opportunity to trade more efficiently. They can find some solace that one major asset manager has decided to use an intermediary instead taking the trouble to trade directly over SEFs, but that manager’s concerns suggest a viable electronic swap marketplace is still a ways off.
“We haven’t signed a single [SEF] rule book and have no plans to do so in the immediate future,” said Michael O’Brien, director of global trading at Eaton Vance, which manages more than $280 billion in assets. “We’re using an introducing broker, and so all the trades we’ve done to date have been through an introducing broker to keep us—at least we believe—out of the compliance risks associated with the rule books.”
Mr. O’Brien spoke at the Commodity Futures Trading Commission’s Technology Advisory Committee meeting June 5. The third panel discussed how to increase buy-side participation over SEFs and provided insight into how the new electronic swap market is evolving.
Large corporates with significant financial components to their businesses, such as insurance and energy companies, as well as companies with large amounts of cash to manage, are considered the most likely candidates to begin trading over SEFs in the foreseeable future, whether directly or through a broker. Regulatory and technology issues tend to be even more worrisome for corporates, which typically have fewer resources to deal with them. In addition, treasury executives monitoring SEFs in hopes of seeing more swap market liquidity and better pricing may be disappointed at this stage.
Another panel speaker, Tod Skarecky, senior vice president at Clarus Financial Technology, said publicly available data indicates that as of mid-May market participants shifted upward of 90 percent of credit-related swaps to SEFs, up from about 45 percent last November when SEF trading began.
However, the much larger fixed-to-floating, interest-rate-swap market that corporates tap more frequently has seen much slower SEF adoption, at 52 percent up from 40 percent over the same time period. A significant portion of those off-SEF trades is the uncleared swaps preferred by corporates that can still be traded bilaterally. Another sizable portion is swaps in which market participants structured maturities that vary from those designated “made-available-to-trade by the SEF, and so are exempted from trading on the electronic platforms. The largest portion of transactions traded off SEFs are forward starting swaps, which increased to 72 percent of off-SEF swaps in May from 54 percent in October.
“In summary, there’s good adoption for credit swaps … and no one is too surprised to see that,” Mr. Skarecky said. “Interest-rate swaps are also showing an increase in buyside participation, but when you look at what’s off SEFs, there’s a vast amount of forward starting trades.”
Mr. O’Brien noted several reasons for the buyside’s slow adoption of SEF trading for interest-rate swaps, including the laborious task of analyzing each SEF’s rules to determine those they’re comfortable with, and then matching those to where they foresee liquidity in a given asset. In addition, he said, the rules are still in flux, so at least for now the Eaton Vance can find many of the exposures it needs using swap futures and other well-understood alternatives.
“When I trade on a SEF, I need to make sure I have in place the SEF, a clearing house, an introducing broker, perhaps middleware, a commission merchant (FCM)….,” said Mr. O’Brien. “There are a lot of moving pieces, and it’s also something I don’t have a long history in dealing with.”
Swap futures offer the same advantages to corporates, but they must be cleared and collateralized similarly to swaps traded over SEFs. Corporates can and typically do use their clearing exemption to avoid that cost, but a proposal expected soon from the U.S. prudential regulators to require banks to impose margin on corporate clients may change that dynamic.
Wendy Yun, managing director at Goldman Sachs Asset Management, echoed many of Eaton Vance’s concerns and added another: SEF rules potentially resulting in fragmented liquidity and market dislocation.
“We would urge the CFTC to consider these concerns in how they implement the rules … as related to SEF trading,” Ms. Yun said, adding, “Taken as a whole, these concerns can have a chilling effect on market participants and their willingness to trade.”