End-users exempted from clearing might find themselves unable to avoid SEFs.
Regulators’ first approval of clearable swaps to trade over swap execution facilities (SEFs) will impact many of the most liquid swaps when the determination becomes effective in mid-February. And for some exempted end-users’ chagrin they’ll nevertheless have to be ready to trade swaps over SEFs.
It is widely understood that swaps approved by the Commodity Futures Trading Commission (CFTC) for clearing—the vast majority—must also be traded over SEFs, new platforms that enable trading in an electronic environment or orally via a trading desk. End users exempted from clearing that use longstanding trading platforms such as Bloomberg or TradeWeb, however, will also have to trade over SEFs, potentially requiring them to complete the laborious “onboarding” process.
“[End users] could do single-bank trading” by calling a dealer, “or if they go to a [multi-bank platform where they receive multiple bids], then it has to be done on a SEF,” said Tod Skarecky, senior vice president at Clarus Financial Technology.
In a recent note to clients, law firm McGuire Woods notes that swaps required to be cleared on designated clearing organizations (DCOs) must also trade over SEFs, but many end users have believed their clearing exemptions enabled them to avoid executing over SEFs.
“This is not the case if an end user intends to use a multi-to-multi trading platform to enter swaps,” the note says, adding that “SEFs are the only multi-to-multi trading platforms available for trading swaps, even uncleared swaps.”
The Dodd-Frank Act required those electronic trading platforms as well as those of inter-dealer brokers to register as SEFs. Corporate end users tend to use highly customized swaps to hedge specific risks, such as the interest-rate risk stemming from a bond issuance, and such swaps are unlikely to be designated clearable and can still be transacted using a single dealer. However, some corporates such as Microsoft engage in at least some cleared swaps and so have also prepared to trade over SEFs, and companies in industries that actively use swaps to hedge risks, such as energy and insurance companies, are anticipated to use SEFs for at least some trades.
The recently approved MAT was submitted by Javelin, a new platform specifically designed to be a SEF. Its first version was very broad, including essentially all swaps between one month and 51 years to maturity. That approach caught flak from swap market participants who viewed the strategy as a land grab, forcing the market to trade on the Javelin platform.
Javelin scaled down the latest version, to cover fixed- or floating-rate swaps in tenors ranging from two years to 30 years. More SEF determinations are anticipated to be approved soon, resulting in a broader selection of swaps that must be cleared and also traded over SEFs.
Corporates trading directly over SEFs have the option of trading on the electronic platform or via the platform’s trading desk over the phone—in both cases they will be exposed to competitive bidding. That transparency is expected to result in more liquidity as well as lower prices.
However, an end user will either have to connect to a SEF it plans to trade over—and probably more than one in order to find the best execution—or build a single connection to one of the emerging offerings by dealers that allow them to trade across multiple SEFs without having to connect to all of them.
“If you currently do trades with your dealer but you want to leverage the extremely low pricing scheme that a SEF may offer for swap executions, you would have to connect to the SEF’s fixed-income trading page and learn the workflow for electronically sending an order for execution via the SEF’s GUI,” says Will Rhode, principal and head of fixed-income research at Tabb Group.
If end users choose instead to use the SEF’s trading desk, each SEF has its own policies and procedures that must be learned. In addition, there are literally thousands of pages of legal agreements and other documents that must be signed, and SEFs retain the right to audit their direct participants.