SEF trading requirement kicks in on February 15 for nonexempt swaps, but how do you trade them?
The Commodity Futures Trading Commission has stuck to its timetable for implementing it requirement that standardized swaps be traded on Swap Execution Facilities (SEFs) as of February 15. Treasurers who plan to use cleared OTC swaps as an alternative to potentially higher costs in the bilateral market, or as an adjunct to bespoke deals, will need to know which swaps fall under the new rule.
The problem is, there is no clarity on how the market will trade the swaps. Initially, market participants expected to trade swaps through agents who belonged to SEFs, much like the FCMs that are members of clearinghouses. However, the logistics of this approach have yet to be finalized, leaving many questions about how exactly SEFs will be accessed come Tuesday, when trading resumes. As it stands, it appears that all swap market participants will have to belong to a SEF in order to trade through it, although most people still expect an FCM-like model to emerge.
The issue is pressing because the SEF and clearing rules apply to the vast majority of interest rate and credit default swaps. The CFTC has issued a press release with a matrix listing the interest rate swap and credit default swap instruments that must be cleared and transacted through a SEF. As reported earlier, the CFTC certified Javelin SEF’s “Made Available to Trade” submission as an approved criteria for determining if a swap fell under the SEF/clearing requirements.
One piece of good news for swappers is the timetable extension provided by the CFTC for so-called “packaged transactions,” which involve more than one leg with at least one leg falling under the SEF requirement. According to a client update by law firm Reed Smith, a packaged transaction involves two or more instruments:
- that is executed between two counterparties;
- that is priced or quoted as one economic transaction with simultaneous execution of all components;
- that has at least one component that is a swap that is subject to the mandatory SEF trading requirement (i.e., a swap that has been made available to trade or “MATTED”); and
- where the execution of each component is contingent upon the execution of all other components.
Reed Smith gives the following examples of packaged transactions:
- Treasury note or Treasury futures vs. interest rate swaps (commonly called an “invoice spread”);
- Swaption vs. an interest rate swap (commonly called a “swap spread”);
- TBA MBS vs.. swap spread (commonly called an MBS basis trade);
- A single-name credit default swap vs. a credit default index swap or “CDX”; and
- A package of two interest rate swaps of differing tenors (a so-called “swap curve”).
Packaged transactions are exempt until May 15 at the close of the day.