Swap execution facilities

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The recently passed Dodd-Frank Act includes a requirement that any participant providing electronic markets for trading interest rate swaps will need to register as a Swap Execution Facility.

Some existing swap trading platforms will have to change the way they do business to meet new regulations now under development, according to Commodity Futures Trading Commission Chairman Gary Gensler.

"I think there will most definitely be change because it will be a far more transparent marketplace," Gensler said in an interview Wednesday. Some swaps trading operations "might, in fact, have to start accepting bids and offers from multiple participants," he added.

Gensler spoke before the agency holds a public roundtable next week where market players will discuss how new swap trading rules should be designed. Key among those rules will be creating a new regulatory category known as a swap execution facility, or SEF. This is a swap trading platform for institutional investors that will promote more transparent pricing and help match buyers and sellers.

SEFs are poised to gain large amounts of business thanks to a provision in the Dodd-Frank Wall Street overhaul bill that requires all clearable swaps to be executed on an exchange, or alternatively, an SEF. The new clearing and trading rules are meant to reduce risk in the system and bolster price transparency in the largely unregulated $615 trillion over-the-counter market.

Many companies that offer some form of swap trading or processing, from IntercontinentalExchange Inc. (ICE) to MarkitSERV and interdealer brokerage firm ICAP, have met with the CFTC to discuss how new SEF regulations will work. With all the new trading business likely to be generated from the financial bill, it's not surprising that all kinds of companies are hoping they can qualify to register as SEFs.

"There are some parties who are looking at swap execution facilities and saying this is a really good thing. It's good for transparency. It will lower risk," Gensler said. "But there are others who are saying 'How do we fit our current model into this new law?' And I think the best way to fit it into the new law is you might have to change."

To qualify as an SEF, Gensler said, a company must offer a "many-to-many" platform, or a platform that lets multiple players transact on swap deals. These new trading facilities will also have to meet certain CFTC core principles. Additionally they must offer real-time reporting on completed trades and promote pre-trade price transparency, he added.

Gensler didn't elaborate on specific changes for existing swap trading platforms under the new pending rules.

But his comments raise questions about the impact on some companies.

At interdealer brokerage firms, for instance, trades are conducted both electronically and on a telephone. This hybrid model is similar to a retail store that lets people order products online or call a customer service center to place an order.

Other existing trading models, meanwhile, enable electronic communication between one customer and many dealers in which the customer submits a bid with the click of a button.

How these kinds of firms can fit the "many-to-many" trading model and the pre- trade price transparency requirements will be important issues for regulators to figure out as they write new rules on SEFs.

Gensler did point out that the Dodd-Frank bill gives the CFTC leeway to craft exemptions to the transparency rules to accommodate block trades, or privately arranged trades executed apart from the public auction market. Block trades are currently allowed in futures markets when customers have very large orders they need to fill.

When asked how voice-brokering of some trades and pre-trade price transparency can co-exist, Gensler pointed out that some trades in futures markets are still brokered now by voice in trading pits.

He said he expects proposed rules on SEFs sometime in the fall, although they won't be among the first rules the CFTC will float.

SEC rulemaking


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