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SEFs Look to Rebound from Summer Doldrums

| FinReg

By Colby Jenkins, TABB Group

Originally published on TABB Forum

Total notional volume traded on-SEF for cleared Interest Rate Swaps dropped for the second consecutive month in August. But early September activity indicates a rebound may be coming.

Despite early summer optimism fueled by record-breaking SEF volumes in June, it would seem the notorious summer doldrums have finally put a damper on the ever-growing momentum of SEF trading.

Total notional volume traded on-SEF for cleared Interest Rate Swaps dropped to $1.98 trillion in August. This marks the second consecutive month of decreasing SEF activity and the second-lowest on-SEF volume in the post-Made Available to Trade (MAT) trading environment (see Exhibit 1, below).

The August drop is even more pronounced when volumes are isolated for G3 currencies. Average notional traded per day dropped 27% from the 2014 high, to just over $86 billion – the second lowest notional average since MAT determinations came into effect.

Despite these recent drops in activity, however, SEF volumes have nonetheless been steadily on the rise since MAT determinations came into effect last February. June was a record-setting month for SEF trading of rates. Notional volumes traded on-SEF nearly hit $2.5 trillion for the month (an all-time record), Dealer-to-Dealer (D2D) SEFs were announcing record volumes on electronic central limit order book platforms, and client-facing SEFs (D2C) in aggregate captured 30% of total SEF trades – up from 8% in early 2014.

Looking to individual SEF volumes, the recent outflow in rates SEF activity is not concentrated among a handful of major firms; rather, it is a relatively consistent trend across all SEFs for the past four months. In terms of month-on-month growth, Dealer-to-Customer (D2C) SEFs have slightly outperformed D2D platforms (see Exhibit 2, below); however, in terms of pure notional market share, interdealer SEFs continue to capture nearly double the notional volume traded via D2C SEFs.

While D2D SEFs may currently be enjoying double the flow that their D2C counterparts currently capture, the activity that these incumbent D2D SEFs capture is, for the most part, pre-existing flow, and each month the percentage going to D2C SEFs increases steadily. This poses a significant challenge for the current IDBs’ business models, and as a result, we expect to see a certain amount of consolidation among SEFs to get an edge in capturing adequate liquidity.

In fact, we may finally be seeing the first steps of this trend of consolidation. Earlier last week, the Wall Street Journal reported that BGC Partners, which operates one of eight D2D SEFs in rates, has submitted a $675 million bid to purchase rival GFI Group. Should this deal go through, the combined market share captured by these consolidated D2D SEFs would put them in a breakaway lead position among D2D SEFs across rates, credit, and FX, and second only to Bloomberg in terms of total notional volume traded via SEF.

In TABB Group’s fourth installment of the SEF Industry Barometer, which was published last week, we asked participants why they felt SEF volumes have not been up to expectation, and the unanimous answer was that trading had shifted to non-standard (off-SEF) tradable swaps. It is, however, far too early to consider these figures as evidence of participants easing away from SEF activity when off-SEF figures reflect a similar drop month-on-month.

What is far more likely is that what we are seeing here is a straight-forward case of the summer doldrums. Early on- and off-SEF September activity supports this interpretation, given that in the first two weeks of the month daily notional traded on-SEF jumped more than 10%, while off-SEF activity remains consistently low. We expect that over the remainder of the month, as traders return to their desks and participants begin to gear-up for the final set of package trade expiry, the month-end figures for September and October should match, if not exceed, early summer levels.