Make or break time for SEFs

IFR 2033 17 May to 23 May 2014
6 min read
mike kentz

Two swap execution facilities have parted ways with their CEOs in the last two weeks in what market participants believe could trigger attrition across the 24 registered platforms. Consolidation has been predicted since the beginning of SEF discussions, but in a surprise turn it could be occurring just as volumes are set to receive a boost.

Jamie Cawley, CEO of Javelin Capital Markets, and Tom Zikas, CEO of State Street’s SEF, have both left their companies in the past two weeks.

Stagnant volumes since the dawn of mandatory SEF trading in February have frustrated shareholders at some of the smaller platforms, including Javelin and State Street. But market observers note that regulatory catalysts for a further shuffle at the top of the SEF pecking order are receding.

“If you haven’t gotten volumes yet, what’s going to change that?” asked one trader at a buyside firm. “It’s been a really tough environment for the start-up SEFs, the market is designed not to allow new entrants. I think it’s getting to be make or break time for these platforms.”

The reasons behind such thin volumes have perplexed even the CFTC, which has direct access to detailed gripes from every sector of the industry.

“We are trying to determine how to improve buyside participation on SEFs,” CFTC Commissioner Scott O’Malia told IFR. “We do know that the legal obligations associated with signing up to a SEF have been a major hurdle.”

O’Malia noted that the concerns included record-keeping requirements as well as ceding jurisdictional control over to the SEF – something the agency will address at its upcoming technology advisory committee meeting.

Packaged expiry catalyst

Additional CFTC relief surrounding packaged transactions that include OTC swaps as one leg of the trade has also kept volume off platforms. Packaged transactions are estimated to comprise more than 90% of dealer-to-dealer trading in the rates market, and more than 60% of the entire dealer-to-customer market for rates and credit, according to traders.

Those transactions were phased on to SEFs as of Friday, when packages that include SEF-mandated swaps against other SEF-mandated swaps were required to trade on-SEF as one unit. A variety of combinations will make the transition at fortnightly intervals to July 16, with a final deadline for swap versus futures or options combinations on November 16.

The market has been burned before by heightened expectations and prophesies of great growth, and this time expectations are being tempered.

“It seems like every time we were supposed to have Big Bang dates it’s been a flop,” said Michael O’Brien, global head of trading at Eaton Vance. “So I don’t think these dates will be major turning points, especially on day one, but these are key focuses for many of us in terms of being able to continue accessing the swaps market.”

A failure to gain volumes could be the final nail in the coffin for many start-ups, which view migration dates as key opportunities to attract volumes and keep their platforms afloat.

State Street believes its new direction, which consolidates four platforms into one, will benefit from the June 16 roll-off, when Treasuries versus swaps spread packages make the electronic leap.

“We’re looking to adapt in a way that makes the most sense for clients, to consolidate our platforms for efficiency purposes,” said Charley Cooper, senior managing director and chief operating officer of trading and clearing at the firm. “If we can prepare ourselves for the packaged roll-offs as well, we believe that consolidation will provide clients an easy way to transact swaps packages and benefit all of our platforms.”

June roll-off

Market participants note that the June 2 roll-off will include compression transactions where old line items are offset with new trades. Some note the pick-up in volume that trueEX has seen on the back of its terminations and compactions product and say that the platform could climb up the market share tables as a result.

“Our PTC [portfolio terminations and compactions] product is ideally suited for MAT swaps versus non-MAT swaps; it provides a customised way to terminate and put on new positions at the same time – especially for the June 2 date,” said Sunil Hirani, CEO of trueEX. “I think it will be a gradual pick-up, though, as the buyside on-boards with new platforms.”

Market participants noted that Tradeweb and ICAP appeared to be leading the pack in terms of preparation for the June 16 roll-off. Traders said ICAP was developing a new style of execution for Treasury versus swap packages that is planned for release prior to the mid-June date. ICAP officials declined to comment. Tradeweb confirmed that the platform was in development for SEF execution of swap spreads.

Not lost on the participants is the schedule for relief expiries. With each occurring two weeks apart, operational builds could be awkward.

“Personally, I think it’s crazy that the reliefs are going to roll off two weeks apart, I don’t understand why you don’t extend relief for six weeks and group the expiries all together at once,” said one bank MD in charge of lobbying and internal infrastructure work.

And if SEFs aren’t able to get their platforms up to speed for the packaged relief, traders may find certain trades more expensive and cumbersome to execute.

“If that is the case and traders have to do each leg of a trade separately, I guarantee it will drive up costs materially,” said a trader at a major asset manager.

Jamie Cawley