Buy Side Needs Better SEF Data
By Haleel Sarwar, Capco
Originally published on TABB Forum
Buy-side firms and commercial clients need transparent trading and liquidity data from swap execution facilities in order to make informed decisions and navigate the new OTC swap trading landscape. But the lack of industry-wide standards on reporting SEF volumes is hindering firms from formulating an effective, efficient SEF strategy.
As of April 2014 there are 24 Swap Execution Facilities (SEFs) registered with the CFTC across Interest Rate, Credit and Foreign Exchange asset classes. Most buy-side firms and commercial clients will typically aim to on-board with a select number of SEF platforms. The selection criteria for these firms will factor trading volumes, liquidity and on-boarding costs, to name a few. There is a need to ensure that the buy-side firms and commercial clients make informed decisions to navigate the new OTC swap trading landscape.
Under the proposed Dodd-Frank regulatory framework, the Commodity Exchange Act (“CEA”)requires that transactions involving swaps subject to the clearing requirement be executed on a designated contract market (“DCM”) or swap execution facility (“SEF”) (U.S. CommodityFutures Trading Commission. “Core Principles and Other Requirements for Swap Execution Facilities.” 17 CFR Part 37, RIN Number 3038-AD18, page 5, para 2).
This regulatory mandate is designed to support the principle that swaps, many for the first time, start trading on regulated platforms and benefit from market-wide, pre-trade transparency. This will help increase the level of trading on regulated platforms, and support the transition to a transparent, risk-reducing swap market structure. Trading over a SEF and DCM promises to improve overall swap pricing and transparency, providing inherent benefits for buy-side firms, commercial clients and other market participants of the swap markets.
SEFs have been live since October 2013 for some FX derivative products, with interest rate swaps going live on Feb. 15, 2014. SEFs started proposing Made-Available-for-Trade (MAT) determinations to the CFTC in mid-February 2014 for IRS and CDS products.
Industry Standard Missing
The lack of industry-wide standards on reporting SEF trading volumes has raised questions about the amount of liquidity in the market and the reliability of the trading volume data. There have been reports of SEFs overstating, exaggerating and double counting volumes (FX Week, subscription required) for marketing and promotional purposes.
In response to the growing frustrations from market participants, the Futures Industry Association (FIA) launched a data recording service called SEF Tracker. This service will publish swaps data across foreign exchange, rates and credit using figures taken from 15 SEFs. Initially the report will be on a monthly basis but with plans for more frequent reports in the future. FIA expects to expand this list if and when other trading venues register with the CFTC.
According to the FIA website, the SEF Tracker report measures trading activity by the notional value of the contracts traded on these venues. While there may be other ways of measuring trading activity, notional value is the only measure currently published by all SEFs.
SEF Incumbents with Largest Market Share
As of March 2014, 90%-95% of SEF trades were executed on dealer-to-dealer platforms, with the four largest interdealer brokers – ICAP, BGC, Tradition, and Tullet Prebon – dominating SEF volumes for interest rate swaps, and Bloomberg’s BSEF dominating SEF volumes for credit default swaps. FX SEF volumes are fairly evenly dividedbetween BGC, GFI, ICAP, Tradition and Tullet Prebon.
The charts below are a snapshot for the month of March of SEF trading volumes for IRS, CDS and FX.
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SEF volumes have continued to increase since the MAT determinations in February 2014. MAT CDS volume traded On-SEF has grown by 350% since the first week of required SEF trading; during that same period, average value traded On-SEF for USD IRS grew just over 60%.
With liquidity growing and concentrating in the MAT trading environment, and a few incumbent SEFs capturing the vast majority of the liquidity, it is important to readily distribute trading data in a transparent manner. The FIA SEF Tracker is the first step toward standardizing reporting of SEF trading volumes, but further refinement of the methodology is required.
Buy-side firms, commercial clients and other non-dealer financial services firms that plan on trading OTC derivatives in Interest Rates, Credit and Foreign Exchange asset classes have to execute those trades over a SEF. These firms will have to integrate SEF connectivity into their existing clearing technology workflows for IRS and CDS products and bilateral trading activity for Foreign Exchange, creating additional complexities and altering current trading models. Additionally, these firms will face challenges when deciding on SEF platforms that meet their trading needs while being cost effective.
Cleaner and transparent trading and liquidity data from the SEFs is important input for market participants to assess the current SEF environment and formulate a SEF strategy (tactical or strategic) across each asset classes.
Haleel Sarwar is a Senior Consultant within the Capital Markets practice in Capco’s Toronto office. He specializes in banking and securities regulatory reform and transformative engagements for Capco.