Q+A-What’s at stake for swap-execution facilities?

By Reuters Staff
September 7, 2010

By Roberta Rampton

WASHINGTON, Sept 7 (Reuters) – The fight over who gets to be a swaps execution facility, or SEF, is shaping up to be one of the most contentious aspects for implementing the swaps portion of the new Wall Street reform law.

Here are some of the issues:


Lawmakers insisted on transparent trading for swaps as part of the effort to decrease systemic financial risks. But because it can be hard to trade swaps on exchanges, they invented a new category of regulated market called a swap execution facility.

The law calls it “a trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce.”

“If the word ‘swaps’ was replaced with ‘goods’ this could be a description of eBay,” wrote Kevin McPartland, an analyst with TABB Group, in an article submitted to regulators last month.

What type of business models meet the broad description given by Congress will be determined by detailed regulations from the Commodity Futures and Exchange Commission and Securities and Exchange Commission under tight timelines.

“Until the CFTC actually issues its proposed rules, no one really knows what a SEF is and what its functionality is going to be,” said Michael Philipp, partner with Winston & Strawn in Chicago.


Companies that traditionally have been big players in the business of trading, facilitating, brokering, dealing and clearing in the $615 trillion over-the-counter swaps market today are jostling to ensure they stay in the game.

A large group of dealers including Barclays, Citigroup, Credit Suisse, Deutsche Bank, Morgan Stanley and others had a conference call with CFTC and SEC regulatory staff last month focused on key SEF issues.

Some players that have already said they will apply to regulators to become SEF, including IntercontinentalExchange Inc, BGC Partners, GFI Group, ICAP, Tradition, Tullett Prebon, MarketAxess Holdings, and MarkitServ, owned by Depository Trust & Clearing Corp (DTCC) and Markit.

Dealers are expected to try to turn private networks into SEFs, and new players also are expected to emerge.


Regulators will define that, too. The new law will require many types of swaps to be cleared through central clearinghouses to make the trades less leveraged, lessening risk. Any swap that clears must trade on an exchange or a SEF.


Exchanges have algorithmic systems for matching up bids and offers, and open order books. It’s possible some swaps might trade on exchanges, but many require some element of customization or negotiation on terms, or are too specialized to trade on exchanges.

The law’s wording may allow for a broader range of models. “You may still be able to keep in place some notion of bilateral consummation of a trade, as opposed to an automated consummation,” said Joel Telpner, partner with Jones Day in New York.


The law says clearinghouses can’t discriminate against swaps executed at unrelated SEFs or exchanges. Some would-be SEFs are worried clearinghouses affiliated with SEFs or exchanges will find ways around this “open access” principle through membership requirements or by preferential fees that encourage customers to trade and clear in-house.

But clearinghouses have argued that they need to be careful not to take on too much risk.

“It all sounds very good on paper to say, ‘Let a thousand flowers bloom. We’ll have hundreds of SEFs. They’ll all hooked to a clearinghouse and everything will be great,’” said Johnathan Short, a senior vice president of ICE, at a discussion held by regulators last month.

“I think we need to go into this very carefully, and I think we need to consider how all of this actually bolts together in the real world and allows the markets to be properly regulated,” Short said.


Rules for SEFs are to be finalized by next July. To meet that deadline, regulators have said they hope to propose draft rules for a host of issues, including SEFs, by mid-December.

But they have a six-month deadline for final rules to prevent conflicts of interest at SEFs, clearinghouses and exchanges, such as ownership and voting limits, governance rules, and access requirements.

(Editing by Lisa Shumaker) ((roberta.rampton@thomsonreuters.com; +202 898 8376; Reuters Messaging: roberta.rampton.reuters.com@reuters.net))

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