A Brief History of SEFs - and a Few Predictions

By Tod Skarecky, Clarus

Originally published on Clarus Financial Technology blog 

The rise of SEF trading over the past 12-plus months has made for a crazy year. In fact, there hasn’t been a year quite like it in the past 20 years of OTC derivatives. Here’s a look at the major milestones – and a few predictions for the next 12 months.

AUGUST 2013 

• There were only 12 SEFs with paperwork into the CFTC; Bloomberg was the only fully approved SEF, and Tullet Prebon had only just submitted its documents. No sign of Tradition or BGC.

SEPTEMBER 2013 

• By the end of September, there were 19 SEFs with paperwork in. The CFTC gave temporary registration status to 16 of them in September, bringing the total number of registered SEFs up to 17.
• In my final blog post of the month, I joked about what was more likely: someone trading a swap on a SEF or someone buying Obamacare online?
• I recall I was due to be in New York on Oct. 2 – go-live day for SEFs – and one of the IDBs had organized a meeting with me for that day. I commented, “Aren’t you going to be busy on SEF Day 1?” The answer was no, hence my forecast at the time for Oct. 2 being a bit dull.

OCTOBER 2013 

• Clarus began collecting and aggregating SEF data on that very first day of SEF activity. I commented in my blogs about just how difficult it was to aggregate the data. Every SEF had different formats, some were not publishing the currency of the trades, others quoting in thousands or millions, some reporting in protected PDF format, and on and on. (This led me to write a blog specifically on the topic of proposed SEF reporting standards.)
• By the end of the month, there were 21 SEFs with applications in to the CFTC.
• By the middle of the month, the first MAT submissions were in. Javelin was first with its blanket MAT filing for IRS, followed four days later by TrueEx, and then Tradeweb (which added credit); MarketAxess snuck in its paperwork on Oct. 31.
• The IDB’s, particularly ICAP, had the lion’s share of activity in rates and FX. Bloomberg was reporting the majority of Credit.

NOVEMBER 2013 

• No-action relief for non-onboarded clients expired on Nov. 1. Funny to look back and think that there were all these clients just dying to use SEFs before they were properly papered and onboarded! The data backed this up, showing only a minor drop in D2C SEF data following the no-action relief expiration.
• Chairman Gensler spoke at SEFCON in New York, where he pointed fingers at a couple of SEFs for not behaving nicely, in the context of an “All-to-All” marketplace. His guidance on “Impartial Access” meant that barriers such as self-clearing status needed to be removed by the SEFs. Hence the doors for the agency execution folks, such as UBS Neo, were cracked open a notch.

DECEMBER 2013 

• Bloomberg got its MAT submission in on Dec. 5, with nothing really added in terms of content.
• Javelin and TrueEx also modified their original filings. Javelin’s was toned down greatly, based largely on comment letters (to put it nicely).
• TrueEx reported its first compaction cycle.
• Lastly, over the course of November through January, the CFTC issued guidance and no-action relief in defining a “US Person” to include US branches of non-US swap dealers.

JANUARY 2014 

• The CFTC had January to provide commentary on the MAT submissions. The October submissions were to be “blessed” by January, with a subsequent one-month lead time until the products being MAT. We pondered what the CFTC could really do (they couldn’t reject them, could they?) and guessed that they would phase in some of the more complex packages.
• By later in the month, the Javelin submission had been certified for the most active USD and EUR tenors, and the CFTC failed to clarify packages, such that the market was left thinking that technically, “If it’s a required swap, even as part of a package trade, it has to be on SEF.”
• TeraExchange announced a partnership with European IDBs, which in hindsight has confirmed what we all were thinking – European banks don’t want to trade on a SEF.
• We at Clarus announced that SEFView, our tool to track and drill into SEF data, was in beta.

FEBRUARY 2014 

• A week before the Feb. 17 MAT deadline, the CFTC added three months of no-action relief for packaged trades, pushing back the deadline to May 15.
• SEF activity slowed down dramatically in that same penultimate week.
• UBS Neo announced it had executed the first IB trade, which happened to be a bunched order done on TrueEX’s SEF that used UBS’s standby clearing to facilitate post-execution allocations.
• Clarus SEFView went live with our first subscribers.

MARCH 2014 

• Credit Index’s became MAT on the first day of March, and credit volumes began their climb up.
• Industry headlines shouted about volumes being off by 30%-50%. Clarus and other data showed, however, that while there was indeed a drop-off through the MAT weeks, it came back into line quickly thereafter.
• For the first time since launch, D2C activity, when looking at vanilla USD and EUR rates and credit, was 50% of the total SEF activity. D2C had accounted for as low as 15%.
• TeraExchange announces the first Bitcoin derivative. (We are still waiting for the BTC MAT filing:)

APRIL 2014 

• Nothing significant happened in April. We were all too busy contemplating what the CFTC might do about the packages coming due in May.

MAY 2014 

• CFTC announces the phased compliance of package transactions, starting with All-MAT packages on May 16, followed by MAT with OTC non-MAT combos June 2, and spread-over US Treasuries on June 16. The CFTC punted packages of futures and other tricky items into November. Plenty of time to sort that out, right?
• ICAP launches IGDL, which would start handling all USD, EUR and GBP rate swaps – the idea being that IGDL is dual-registered as both a SEF and an MTF, such that the marketplace has both US and European liquidity. I’m still not sure if the T’s were crossed and I’s were dotted on that, but it is what it is.
• Bloomberg turns on its SDR, aptly named BSDR. All of its SEF trades (less some non-cleared outliers) start being reported there instead of DTCC.
• Given all of the package exemptions, I estimated a slow grind up in activity, yet still calculate that no more than 75% of the market would be SEF-able. (I am proven right!)

JUNE 2014 

• The next two package exemptions roll off (MAT/non-MAT and spread-over treasuries).
• D2C SEF’s continue to show growth. This time, Tradeweb comes in with some big numbers.
• Clarus adds Eris and CME swap futures to SEFView. Data reinforces that the market has not moved to futures, yet.
• TeraExchange does its first SEF trade (in USD, not Bitcoin).

JULY & AUGUST 2014 

• Volumes remain typical for the summer.

SEPTEMBER 2014 

• Each of the four weeks of September see record highs for SEF activity.
• BBG introduced CLOB pricing alongside its RFQ mechanism, and we hear stories about some of the IDBs doing 40 percent of their activity electronically. Did it just take a year to get some of this done “e”?

OVERALL SEF ACTIVITY TRENDS 

Charting SEF activity, we can make out some of these events described above. Eyeballing the chart below showing all activity spanning IRD, FX and Credit, you can make out the Feb. 17 MAT weeks and the highlights in the month of September.

52 weeks of SEF Activity – ex-FRA and OIS 

LOOK AT EACH ASSET CLASS 

Looking at the data by asset class, we can see the vast majority is in IRD, which has had some steady growth. FX and Credit, while paling in comparison, have also shown similar growth.

SEF Activity by Asset Class by Week 

LOOK AT D2C VS. D2D 

Here you can readily make out that the growth has been in the client SEFs. Interdealer activity has plateaued.

SEF Activity by Legacy SEF Type 

LOOK AT FUTURES 

Whittling the data down to just USD Vanilla swaps and their USD Swap Future cousins, we can also see that swap futures have not presented a real threat. Any blips would seem to be the quarterly contract rolls.

USD Vanilla Swaps – OTC & Futures 

WHAT LIES AHEAD – PREDICTIONS FOR THE NEXT 12 MONTHS 

Crazy year. No other year quite like it in the past 20 years of OTC derivatives. I have a hard time seeing how the next 12 months could trump this one. But here are some predictions anyway.

[Related: “SEF Volumes Will Rise, But Long-Term Pessimism Persists”] 

ORDER BOOK: There have been a few press releases over the previous months speaking about the growth in some of the IDB order books. I am a believer that electronic order books will ultimately be the sources of liquidity for the liquid products that comprise 60%-70% of the market. There is just no fundamental reason this wouldn’t be the case. In other asset classes, it took a while, but when it happened, the shift occurred and was permanent. The same will surely happen. Within the next 12 months? I would say yes.

MORE MAT PRODUCTS: So you have come to learn that trading your spot starting swap has to be done on-SEF. This required lots of pain, be it legal, operational or technical; but the investments have been made. Now that we have arrived, you have to ask yourself: Does a four-day forward start swap really mean you have to pick up a phone? Another MAT submission will happen, and it will be justifiable.

MAC & FUTURES: There will always be the bespoke nature of the swaps market. However, I see growth in the standardized MAC contracts as good approximations that yield cost benefits that outweigh the small basis risk. Further, liquidity providers will prefer these products as cheaper to margin and process. The CDS market had a big bang, but I project a slow bang in rates in these standardized contracts. I think that shift will be visible within the next year. The next logical progression is into trading these products as futures. I’m not as bullish on this happening within the next 12 months, but I do see growth in futures within this coming year; however, I do not believe it will constitute more than a handful of percentage points. Yet.

FOCUS ON MARGIN: Over the past year there has been a lot of expenditure by firms on compliance. I see compliance costs taking a turn back toward earth. What’s next is capital. I’ve been shocked to find that firms, both buy-side and sell-side, have been generally oblivious to the costs associated with collateralizing their OTC derivatives with a central counterparty. For some, it’s because they haven’t historically had to pay margin. For others, it’s because their cost of capital has been low in the current low-rate environment. All we need is for rates to inch up, and that suddenly constitutes a doubling or tripling of funding costs for many firms. Desks will quickly be forced to behave smarter about their funding costs, and margin will be of primary importance.