The proposed Commodity Futures Trading Commission rule requiring swap execution facilities to incorporate a 15-second time delay on swap trades has been around since last year but the practicality of such a rule still generates enough heated discussions in the swaps industry to fill an entire conference room. At least that was the sentiment today at the Wholesale Markets Brokers’ Association’s second conference on Swap Execution Facilities.
The Commission proposed the rule in section 37.9(b)(3) in its Notice of Proposed Rule Making, which requires swap execution facilities (SEFs) to have the delay between two swap orders when one party is a customer and the other a trader or in the case of two customers.
Participants have questioned whether having such a time delay — even 15 seconds long — would help either side of a swap trade. They particularly do not see how applying the rule to requests for quotes (RFQs) during the swap trading process would be a benefit.
Michael Gooch, chairman and CEO of GFI Group said he does not believe the proposed 15-second rule as it stands has been fully defined and is likely to cause a lot of problems for swap players.
“Conceptually, I see it as extremely problematic in many different respects. If two large counterparties entering into a transaction need to display their transactions for 15 seconds in the market place before that transaction is completed, for starters, you’re going to have traders in the underlying cash position have a 15 second head start to trade the order,” he said.
Having the delay opens up the potential for a third party to come in despite two parties having already agreed on terms and “pick off” and trade ahead of the order. It also gives little incentive for those dealers who are making the markets in the first place.
“It’s an important issue. Certainly in an auction based protocol like we offer at MarketAxess, there’s a significant amount of competition that takes place pre-trade to get to the best dealer price. The client can execute on that dealer price immediately,” said Richard McVey, chairman and CEO of electronic trading platform MarketAxess.
It “adds a lot of uncertainty to both the dealer and client to require the 15 second rule where other people can get in the mix after they’ve seen somebody lead with the best price,” he said, noting it undermines the auction process.
In an active interest rate swaps market, for example, most participants believe the 15 second time delay is too long, and in other swaps markets, such as within renewable energy, the delay could actually disrupt the market entirely since there are so few players.
Trade groups like the International Swaps and Derivatives Association have long maintained the rule should apply in the limited circumstance when a dealer is contacted by one of the dealer’s customers with an order to execute a trade on an order book, and should only apply to two orders being entered on the same order book.
Despite the regulatory battles in using SEFs for swap trades, a barrage of firms are still looking to set up the vehicles. But the ones most likely to survive and be profitable are expected to be the first firms out of the starting block.
“The liquidity gathers around one or two market leaders,” noted MarketAxess’ McVey. “Once a trading system has proven technology that makes trading more efficient with quality pricing and adequate liquidity providers, the marketplace does move toward that system and I would expect there would be significant differentiation between SEFs.”
MarketAxess’ primary swaps focus in setting up its SEF, for one, is credit default swaps, but it is considering eventually offering interest rate swaps. “We are open to adding other product areas along the way. The most obvious for us to think about is adding interest rate swaps,” he said.
Before any of the swaps rules get worked out, however, Congressman Carolyn Maloney (D-NY 14) added at the conference that it is crucial for the CFTC to align closer with the Securities and Exchange Commission’s swaps rules. She disagrees with several CFTC proposed SEF rules.
Maloney was an original co-sponsor of H.R. 2586, the Swap Execution Facility Clarification Act, which Congressman Scott Garrett (R-NJ5) introduced last July. The Act makes it mandatory for the CFTC and the SEC to finalise SEF rules that allow the swaps market to naturally evolve towards the best form of execution.
“To get it to the end game and signed into law, we need the regulator (CFTC) with us,” she said.
Kathleen Hoffelder