SEF Market 2014 - Euromoney

8/11/2019 SEF Market 2014 - Euromoney

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THE STATE OF THE SEF

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4/20SEF MARKET DESTINATION UNKNOWN4 AUGUST 2014

In this report, Euromoney Research Groupsheds light on the trials and tribulations of theintroduction of swap execution facility (SEF)rules in the US and its effects globally.

After the shock of rapid and sweepingstructural market changes, we talk to one of

the regulators instrumental in establishing them.US regulators are now working out the kinks in

the legislation and hopes are high for continuedadoption of this way of trading.

To ascertain the remaining challenges,we surveyed FX and IRS market participants,including buy-side rms such as hedge funds,banks, corporates and insurance companiesall around the world. ERG also spoke to themajority of market-leading SEFs to get their

views on where this market is going.Issues covered in this report include the

continuing global regulatory work, as countries

attempt to comply with the principles agreedat the G20 Pittsburgh summit in 2009. We askwhether enough cooperation is happeningamong regulators and what can be done tospeed up the process. We uncover the barriers

to trading on SEFs and what market participantssay will encourage them to transition to this wayof doing business.

Throughout the process we found marketparticipants to be open and honest about

the dif culties faced and those that lie ahead.Underneath it all, however, was a con dence

that everyone will bene t from the increased transparency that is at the heart of introducingSEFs.

Catherine SnowdonEditor, Euromoney Research Group

EUROMONEY RESEARCH GROUP THE STATE OF THE SEF MARKET DESTINATION UNKNOWN


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SEF MARKET DESTINATION UNKNOWN 5AUGUST 2014

Euromoney: Are you happy with how theintroduction of the SEF regulations hasgone so far?OMalia: I am very optimistic about swapexecution facilities (SEFs). We were able tocreate an environment that was exible, thatwould give everybody the opportunity to nd

the best way to transact their products andrecognize the differences between the swapsand futures markets.

There are large notional size trades, butrelatively few of them. So weve shown thatpeople can transact through an electronicplatform so we get the transparency that suits

the market and our regulatory purpose. Nowwe are trying to gure out the best way to reallymove this forward.

In credit default swaps youve got tremendous uptake on screen, but these aremore standard products of course. Dollar-denominated interest rate swaps are seeingmore volume than non-dollar-denominated. Ourchallenge is to bring more liquidity to the marketand more buy-side participation.

Poor buy-side participation is eminentlyxable. Any issues they have regarding SEF

access, rule-book issues, how many SEFs theywant to access, what products are being traded,where the liquidity is in these markets - thoseare the issues we want to attack.

What about broadening the range ofproducts available on SEFs?

We need to consider newer products, suchas packaged trades. We have more and moreof these going on-screen: lets see if that helpsincrease participation.

Weve spelled out a schedule for newproducts so people have some certainty. Itsimportant to phase these things according to

the complexity and different features of eachproduct.

For example, if the CFTC determines thatnon-deliverable forwards (NDF) are suitable for

clearing, the next step will be to determine theprocess for making them available to trade.

When it comes to NDFs, Ive heardconcerns about integration, physical connection,

transaction integration, clearing and exchange trading intermediation and so on. This is not thefutures market. We need to understand if thereare complications around the role of primebrokers, for example.

But as I understand it the NDF proposal iscomplete from a staff level and it is ready to go

to the CFTC fairly soon.

How aware are you of the widespreadconfusion in the market when it comesto the SEF rules?I am very sympathetic to the marketplace and

their level of confusion. We have gone througha three-year rule-making process in which wevedone 68 nal rules. We have rushed through

these rules at record pace. Ive never seen anyother federal agency move this many rules

this quickly. And as a result weve made somemistakes.

Our challenges manifest themselves in thedata. Weve had well over 190 staff no-actionletters [statements overriding or changingspeci c parts of the nal rules]. Weve issued

temporary relief, permanent relief and everyvariety thereof, all trying to accommodate therules.

Im supportive of the no-action reliefobviously because we have to offset the rush

that we did the rules in and the complications that weve created as a result.

My frustration is when you look at theentire way weve gone about this. Going soquickly we havent asked the right questions.

We didnt expect many of these outcomes andas a result were actually backtracking through

the no-action relief to try to accommodate technological policy changes that the market isnot ready for.

What are you doing to address theissue?Early on I have been consistently asking fora schedule, what rules we are going to do

and when, so people can get their mindsaround the rule order and the phase-in of theimplementation dates.

The market needs to know when theyneed to have connections, relationships andnew paperwork in place to make sure they areable to trade and clear all of these productsas expected. And report data too, which isimportant.

We also need to consult the market andask what is possible. The schedule is a problemand its been a consistent problem for the past

three years.

What sort of response do you get fromthe market when you ask questions?The market has had a very steep learning curve.Early on there was a little bit of denial about theexpectation of how far we would get and howquickly we would get there.

But everybody now completely understandswhat the rule set looks like.

They are anticipating and helping usunderstand how the infrastructure, the SEFs,

the clearing houses and the data reporting willfunction and does function and what can bedone in what period of time. Thats very positive.

INTERVIEW:SCOTT OMALIA,COMMISSIONER, CFTC

When Scott OMalia approved the nal swap executionfacility (SEF) rules in August 2013, he did so reluctantly.His fears were realized when the regime quickly wroughtinternational havoc. In one of his last interviews beforeleaving the US Commodity Futures Trading Commission(CFTC), he relives the ordeal of bringing these rules tomarket and highlights many of the challenges still to come.

I am very sympathetic to the

marketplace and their level ofconfusion


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SEF MARKET DESTINATION UNKNOWN6 AUGUST 2014

What happened to make marketconsultation ineffective before the ruleswere released?People got confused by the lack of speci city inour questions. We werent able to pull the rightinformation out as a result and the industry was

left guessing what we wanted. So there has beenmiscommunication and false expectations aboutwhat these rules were going to be.

Footnote 88 had wide implications. Werethe effects intended?This is where our cross-border rules over-reached. We were trying to guess at some of

these things and what the rami cations wouldbe. When we read the statute we knew wewere well beyond our ability to enforce it. Thestatute essentially says we can apply our rulesextraterritorially to the extent it has a direct andsigni cant impact on our economy.

So you have to ask yourself, what is a directand signi cant impact? We never received asatisfactory answer as to how a US personinvolved in exchange trading outside the USwould bring risk to our shores, especially if the

trade is cleared. We just applied the rules broadly and as a

result we over-reached. We hurt relationshipsinternationally by expecting to apply our rules inforeign jurisdictions.

Instead we should work with colleagues

internationally to make sure we have thecomparable rules that we can all rely on.Share the data and have the con dence thateach others clearing houses are robust andcompletely in line with international standards.

Then with execution we can work out deals to make sure we have that comparability so youdont create an arbitrage opportunity that wouldexcuse people to trade somewhere else andundermine our rules. But at the same time wedont police the world, so we have to do this in acooperative fashion.

Do you remember how long you had toread over the rules before they becamefnal?

We negotiated them for over a year. Butfootnote 88 came in at the very last minute. Itwas not in the draft proposal that the marketsaw. It came into the nal draft; the market didntsee this thing coming.

Europe didnt have any reason to fear a SEFrule that was to be applied domestically but

then all of a sudden it applied everywhere. Andyou begin to understand, this is crazy. Tradersin Europe, trading and clearing there but witheither a lawyer or some expert here, and all of a

sudden its a US trade. It doesnt make sense.There is a lot of energy spent trying to

understand and comply with the rules when,had we made them with a more internationalmindset, we could have saved everybody a lot of

time and energy.

Turning to international cooperation, isenough discussion happening betweenregulatory bodies around the world?From the beginning weve had good relationshipsand good intentions among all the regulatory

entities. There are some differences in the rulesets and there are certainly timing differences,which bring certain challenges.

Asia is not as keen on exchange trading andwe have some clearing and trading timetabledifferences with Europe.

Data is a great test case. Everybodyfundamentally agrees on the objective and weare all in a process of implementing swap datarepositories.

Now we have to solve the really dif cultchallenge of harmonizing the data. We need tounify, as regulators, that form and format the data

should come in, so we can begin to share it anddo broader market analysis.

We need agreements to be able to share the data. Because as appropriate from time to time we will need to share information aboutcertain market participants. Or simply comparenotes about where there is risk build-up.

Weve made some headway. We have thefacilities in place and we have reporting. The UShas had reporting for over a year, Europe wasntfar behind, but we need to take the next stepsand we need to do so immediately.

This is a dif cult situation to manage. Data iscomplex and it requires very speci c outcomes

Scott OMaliaCFTC Commissioner

Footnote 88 says that a facility would berequired to register as a SEF if it operates ina manner that meets the SEF de nition eventhough it only executes or trades swaps that arenot subject to the trade execution mandate. This changed everything Brought many more products into SEF realm Rules applied to trades with all US persons If a US entity was involved somewhere inthe trade, the rules applied Caused shockwaves around the world

Footnote 88:


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and inputs and we need to make sure that weunderstand what those are so we get good-quality data.

Right now I would characterize our dataquality as poor. There are inconsistencies comingin in terms of how people report and we have

four different data architectures that make our job more complex.

What about when it comes to clearing? We have clearing houses internationally; weknow the standards and we understand what therisk management and oversight responsibilitieslook like. Weve been doing it for years. Itsimportant we get international recognitionsooner rather than later for one anothers

jurisdictions because weve all agreed to thePrinciples for Financial Market Infrastructure.

If we dont recognize global clearingstructures we will fracture liquidity and that couldbe intractable for a while, which wouldnt begood for anybody.

Ive sent a letter to commissioner [Michel]Barnier [European commissioner for internalmarket and services] making sure we stayfocused on these issues and I know they aresupportive of these goals. But at the same timewe actually have to recognize one anothers

jurisdiction and the entities within it. We are never going to get to a rule-by-rule

analysis. Its an outcomes-based objective; we

have to be exible to some extent so we cancontinue to recognize one anothers rules even

though they dont exactly match up.If we try to make them exactly match up

we will not succeed. There has to be a dialoguewhich is a little bit more aggressive in terms ofgetting to outcomes by the end of the year toachieve them.

Thats the set timeframe?My understanding is that December 15 is a harddeadline for European clearing houses to comply[with European regulations] and the market

needs that certainty. They need to know theschedule and which clearing houses Europeanswill be able to transact with.

They need to be able to make the decisionsand, if it comes with conditions, what they are.And how dif cult they will be to comply within

the timeframe.

Do you get a good response whenyou engage in conversations with yourregulatory counterparts around theworld?Absolutely. The US in my opinion had a broadoverreach of our cross-border rules and that

hurt negotiations going forward. It damaged therelationships in some respects.

We are doing a good job of healing those,.but we have to demonstrate that by action not

just by words. The easiest and best rst stepwould be on data. Lets get to a recognition ondata harmonization.

Weve taken some dif cult steps and notnecessarily successful ones on trading. We have

the most time on trading; Europes tradingmandate isnt until 2016. We now know what

their rules, by and large, look like for multilateral trading facilities [the European equivalent ofSEFs]. Having discussions now about timing andstructural differences between the regimes willbring about better regulatory harmony when the

trading mandate in Europe occurs. Weve sent enough letters back and forth.

Now its time to sit down, put our lists on the table and work out how to solve our differences.

Asia seems a long way behind in termsof adopting similar rules. Does that

worry you?Im not so worried about it because speakingwith the regulators throughout Asia, they arecommitted to this effort. Liquidity in thosemarkets is less and the size of the markets issmaller but I dont have a sense that they are anyless committed to making the necessary reforms.

Were going to have to adjust for time but I dontsense any lower dedication to the end goals.

What about the idea of a universal rulebook for SEFs? Could that work?No, its not possible. This is a principles-based

system of outcomes, we are never going to beidentical. Its about accepting the differences andhow you are going to solve those.

There are questions about theconsistency of data being reportedin the SEF market. Do you regret notbeing prescriptive enough in the rules?

With regard to data you have to be veryspeci c about what you want. We have

questioned the market about how to improveour data rules. We need to eliminate theinconsistencies between the various r ules toimprove data quality and reporting.

We dont want a rule set where thereare various possible outcomes. To provide thatcertainty will improve the quality of the dataand allow us to get what we want out of it.

We went into this asking for everythingand not knowing how we would use it or forwhat purpose. Ive challenged our staff and

the CFTC to think about our priorities in dataand technology. Now that we see how big achallenge the data is, we are not going to beable to do everything immediately.

Whats your top priority?I would put risk management at the top of thelist. Understanding bilateral risk managementor knowing in which asset class we are seeinga big build-up of risk. The London Whale wasa good reminder that these things can happen.

We need to have very clear insight into whatsin the clearing house and whats outside it andknow where risk is building.

Its a very exciting opportunity; we nowhave all of this data for the rst time. We arelooking at how to use it to best effect.

You are forward-thinking when itcomes to the use of technology. What isyour focus?Data integration is key. You cant develop

the full picture without pulling all the pieces together.

Were looking at what it means to havecomplete surveillance of our markets and how

to do comparative analysis between nancial

products. You have to always be thinking aboutcross-market trades as well. Working with Finra[the US Financial Industry Regulatory Authority]and the SEC, we need to think about what thenext generation of data surveillance looks like.

Ive been advocating for a strategic planlargely because we need to put on paper ourpriorities based on our mission and needs. Weneed to understand what we need in terms ofhardware, software and personnel expertise.

We need more data scientists peoplewho can work with the data effectively, whocan programme and develop automatedsurveillance tools. The massive amount of data

The US in my opinion had abroad overreach of ourcross-border rules

Right now I wouldcharacterize our data qualityas poor


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that we take in is not something we can throwpeople at; this has to be an automated process.

After all, you are taking on anautomated market.Exactly. They are trading in a 21st-century way,

we are surveilling it in in my opinion a very20th-century way. And thats just not going tobe a successful endeavour in the long term. Weneed to adjust to the realities of the way themarket trades.

We need to bring in order data, somethingIve been asking for and something weveprovided absolutely zero funding for this year. Inautomated trade tools, the behaviour and how

they trade is in the order data, not necessarily in the transaction data, which is almost stale.

Expanding the types of data we collect willbe a learning experience; its not somethingwell be able to quickly intake. Its a massiveamount of data, physically. And then to do theanalysis, its a huge task. But we need experiencewith that now, so we can be effective in thefuture.

Id like to see a bottom-up approach, have the divisions in this building tell us what theybelieve their priorities should be and then theCFTC can take all the different priorities andknit it together for a full strategic plan. It has tobe a one-year and a ve-year vision, because

this isnt going to be done overnight. Waiting

for this strategic plan is painful and its longoverdue.

Statutorily we were required to implementa strategic plan one year after the presidentsinauguration. Were well past that date.

Whats causing the delay?A lack of focus on the speci cs. We haventfocused intensely enough on our priorities and

the speci c technology and mission functions that we want to achieve. Those are harddecisions to make but there hasnt been enoughattention paid to it and therefore we dont have

any results to show for it. I keep talking about it,raising the pressure and the issue to hopefullycreate some sort of catalyst in order to get thisdone.

Do you have a technology team, withdata analysts already?

We do, but we dont have nearly enough. Wehave different skill sets, some are very good withprogramming, some with market surveillance, but

there is a lot more that needs to be done. It willbe dictated of course by the mission we take on.If we are going to expand, for example, our riskanalysis, thats a different skill set we need.

Do you have enough staff with the rightmarket experience to oversee thiscomplex market?As a result of the rule-making we have reallyenhanced our market knowledge. This is amarket that was outside of our jurisdiction,so there shouldnt have been an expectation

that we knew everything about it. But it is nowcompletely within our jurisdiction and we arebuilding a lot of knowledge and experience.

Our learning curve has been steep butwe have tackled it very well. I am impressedwith the enormous amount of hard work,

time and energy that has gone into this. Thestaff have learned fast and tried to write rules

that accommodate the nuances and uniquecharacteristics of the swaps market.

By and large we got them right, butwe made some errors. Now we are in theimplementation-correction phase. If we stoppeddoing the corrections and said we got it right

thats when wed have problems. We are willing

to consider changes and that is healthy andappropriate.

What about start-up SEFs strugglingwith poor volumes and slow uptake?Do you expect to see consolidation?I appreciate that the willingness to invest in

these and try new technologies and innovations takes great commercial spirit. And I know thatof the 20-plus SEFs that have come in forregistration not all will survive.

But I like the different ideas that peopleare coming up with and the different products

coming out. Innovation is going to be a great thing for this market and it will create newopportunities.

I cant predict where this will end up, but

we are looking at ways to get more tradingdone on-SEF and allowing people to transact in

the way they want to.SEFs are going to continue to evolve and

I dont want us to insist on a single solution;we need to learn from the equities market in

terms of fragmentation and what can happen there. This is a new market and we need tostay exible and think innovatively, just like themarket participants are.

What has been the biggest challenge inyour term?Its dif cult when you are presented with whatis deemed a consensus document led by thechairman and supported by the staff and told:Here it is, take it or leave it.

The hard work has been to try to forecastwhat could and might go wrong and to do myown independent research and analysis intohow the market might not function as well asexpected under this rule.

That requires a lot more work on our side.My staff have had to work very hard to thinkcritically and anticipate something other thanwhat is being sold to us.

Are you likely to seek another term?[With a wry smile] I do love this job. Ive hada lot of experience on Capitol Hill, developingrules and statutes and I thought that was a

terri c job. But to have the opportunity tobe on the receiving end of the statute andbe asked to get the details right is different.And the details clearly matter, so to take it

to the next level in terms of policy analysis isfascinating to me. Ive enjoyed all of my policy

jobs here in Washington but this one is special.The stakes are very high and the outcomes areimportant.

[Since talking to Euromoney, OMalia has formallyresigned from his post at the CFTC. He willtake up the position of chief executive of the

International Swaps and Derivatives Association on August 18.]

This article was frst published on August 8

I know that of the 20-plusSEFs that have come in forregistration not allwill survive

We need to bring in order data, something Ive beenasking for and something weve provided absolutely zerofunding for this year


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The introduction of the US swap executionfacility (SEF) rules has caused problems, globally.Markets have battled to adjust to this new wayof trading and the ght, for many, is not over.

The concept underlying the rules wasstraightforward: at their September 2009 summitin Pittsburgh, G20 leaders agreed that by the endof 2012 at the latest, all standardized over-the-counter (OTC) derivatives should be traded onexchanges or electronic trading platforms whereappropriate. The International Organization ofSecurities Commissions (IOSCO) was involvedfrom the start, setting out detailed principles forsecurities regulation. Although no G20 membermet the 2012 deadline, the US has takensubstantial steps towards full implementation.

On July 21 2010, president Barack Obama

signed the Dodd-Frank Wall Street Reform andConsumer Protection Act (Dodd-Frank Act). Thelegislation tasked the US Commodity FuturesTrading Commission (CFTC) with overseeing alarge part of the US swaps market.

The nal rules were ready by August 2013and set out their goals:

Title VII of the Dodd-Frank Act amended the CEA [the Commodity Exchange Act,which lays out the statutory framework underwhich the CFTC operates] to establish acomprehensive new regulatory framework forswaps and security-based swaps. A key goal of

the Dodd-Frank Act is to bring greater pre-tradeand post-trade transparency to the swapsmarket Such transparency lowers costs forinvestors, consumers, and businesses; lowers therisks of the swaps market to the economy; andenhances market integrity to protect marketparticipants and the public.

A level playing eld for market participantswith better transparency and lower risk promptsno complaints. The rules and guidance that camewith them de ned the type of trading platformsrequired to register as SEFs, the core principlesby which they must operate and the executionmethods to be used. Simple? Or not?

When research on this market is undertaken, the word most commonly used by marketparticipants to describe the rules is confusing.The task of deciding how and when to phase in

these regulations and who would decide whichasset classes and instruments they would apply

to must have been daunting. As outgoing CFTCcommissioner Scott OMalia acknowledges,mistakes were made along the way. But thoseclosest to the market understand the dif cultiesinvolved and accept that the US moved quicklyin an attempt to give markets certainty as soonas possible.

The EU is following a principles-basedapproach and is taking longer to come up with

the regulations, says Paul Millward, productmanager FX at GFI Group (a SEF). In the US

the rules were nalized much more quickly. Theyare clear and well de ned although of course

there are still issues that need to be worked through.

Scott Fitzpatrick, chief executive of TraditionSEF, says: The CFTC came out of the gatesvery quickly, and were very aggressive with their

timelines for implementation. To an extent Irespect that they went rst, someone had to. ButI dont think they spoke to enough people forlong enough before they issued these rules.

Some observers try to look for the positive

aspects of the US racing ahead in introducingregulation.

In coming out with their rules so fast, the US is giving us empirical evidence of howmarkets and liquidity are affected by this type ofregulation, says Peter Best, chief operating of cerat Icap SEF.

Unintended consequencesEven the most pragmatic of market participantswere shocked by the way the rules were blastedout however. Last-minute changes had large,possibly unintended, consequences. The mostprominent example of this is footnote 88.

The footnote says that a facility would berequired to register as a SEF if it operates ina manner that meets the SEF de nition even

though it only executes or trades swaps that arenot subject to the trade execution mandate.

This changed everything. Before this point,products would only have been required to

trade on a SEF if they were subject to themandate, which was only applicable to products

that were required to clear. Add in that the rulesapplied to trades with all US persons. Thismeant that whether or not the person actuallydoing the trade was a US citizen, if a US entitywas involved somewhere in the trade, the rulesapplied. This generated shockwaves around theworld in the complex global markets.

Market participants describe being abbergasted and stunned when they read

the footnote.Prior to SEF rules being published, people

expected the rules to be applied incrementally,says Best. Footnote 88 threw people off. It cameas a shock to the industry and the logistics ofdelivering on these rules proved challenging.

Fitzpatrick of Tradition SEF adds: Thatfootnote took this from being a relatively logical,narrow-scoped set of products that weregoing to be subject to mandatory clearing andeveryone knew would ultimately be subject tomandatory trading, primarily in the US between

FROM CONFUSION TO CONSOLIDATION

Swap execution facilities were supposed to bring transparency and price cer tainty for the whole market.Instead, though, they have forced traders back onto

the phones and fragmented liquidity internationally. Butwhether markets like it or not, the changes are here tostay, so how best to adapt? Euromoney Research Group investigates.

I believe well see a ight toquality, only the strongest SEFs willmake it

Zohar Hod, SuperDerivatives


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US participants, to instead affecting your entireglobal swaps business. It was incomprehensible.From being a US issue, this became a globalimplementation of CFTC rules. It was acompletely unmanageable situation given the

timelines that were being set out. There wascertainly a moment in time where we weredealing with global chaos.

George Harrington, global head of xedincome, currency and commodity at Bloomberg ,says that although the situation is now improving,

footnote 88 did not help proceedings. The lackof clarity in the rule-making process has causeda level of uncertainty in the market, he says.Cross-border guidance has sometimes beencon icted and, as a result, many participantschose alternative execution methods to SEF

trading.For the FX market, the shift caused by

footnote 88 was particularly shocking as it meantmarket participants were drawn into the fraylong before they expected to be.

In terms of impact on the FX market ithas meant lots of work for the venues, to be

assessed to comply with and meet the SEFregistration requirements, says Best. Platformswith an FX bias werent prepared for this.

The footnote also had implications for thebuy side.

Non-deliverable forwards [NDFs FXinstruments traded on SEFs] were slowlybecoming increasingly electronic before theserules, says Michael OBrien, director of global

trading at Eaton Vance. Now, he adds, his rmis back to trading FX on the phone in order toside-step the SEF rules.

The slow adoption of trading on SEFs by the buy side is a worry for SEFs, particularly

the start-ups that need clients to make theirinvestments worthwhile. For some, the negativereaction was expected.

I think the buy-side response generally to this regulation, and to all regulation that Ive everseen in my career, is: This doesnt help me, itscomplicated and I didnt ask for this. And thatis what we are seeing., says Jodi Burns, headof regulation for marketplaces at ThomsonReuters. I dont think it should have been asurprise to anyone. I think you have to takea long view when it comes to assessing thebene ts of regulation.

For OBrien the delayed uptake is more than justi ed. Were talking about a giant, rapidlychanging market structure, he says. I knowpeople have put money into SEFs and variousdifferent business models that rely on the buyside coming to the SEFs, but my concern is ourfunds shareholders, not whether someones

business model is justi ed or not.

Complex on-boardingThere are a few reasons for the slow uptake ofon-SEF trading. A big one is the arduous processof on-boarding with each platform. Clients mustagree to sign up to a rule book, which is differentfor each SEF they want to trade on, and can runinto the tens or even hundreds of pages.

From an asset-manager perspective wehave to think about how this ts into our internalagreements and relationships with clients, says

OBrien. Can we sign up a client for this? Oneof the fears in the beginning, and no one talksabout it anymore although Im not sure itsbeen addressed, is if I trade on a SEF for a clientaccount, does that mean the SEF can go andaudit the clients books? Once you start to think

through some of these things, its insane. SEFs willsay they dont plan to do that, that they have tohave that language in the rule book by regulation,but that doesnt mean I want to take that risk. Iknow a lot of buy-side rms have signed up for

these rule books, I dont know why.The process of on-boarding is also a big

undertaking for the SEFs. Bloomberg has taken

a client-by-client approach.We work with a wide spectrum of clients

that represent a number of different geographiesand sizes, says Bloombergs Harr ington. Our SEFhas more than 800 global participants and more

than $5 trillion has been executed (across credit,

rates, FX and commodity derivatives) since ourOctober launch. Each of these clients has speci cneeds, but our general approach is to understand

these needs and how they can bene t from ourSEF technology and experience.

Once a client has signed up it must beaware that it is transacting in a constantly shiftinglandscape.

Rule books across the SEF community arechanging monthly for all sorts of good reasons,like expiry of CFTC no-action relief lettersand so on, says Fitzpatrick. No-action reliefletters have been issued by the CFTC to relievemarket participants from parts of the ruleswhile regulatory kinks are sorted out. They areeffectively temporary or sometimes permanentrule changes and all 190-plus of them must bere ected in the SEFs rule books.

SEFs have to update their rule books as theCFTC provides further guidance on the rules,says Grigorios Reppas, CDS product managerat MarketAxess . In the beginning we wereupdating every week, now its about once every

two months or so. But that could change again.Burns of Thomson Reuters, thinks a process

of adjustment is needed. The buy side is lessused to being regulated; they dont all have acompliance of cer and an army of lawyers tohelp them gure out what the rules of conductare, she says. The idea that they have to agree

to abide by a rule book is a foreign concept to them. There is seemingly no upside to joiningSEFs directly. It opens them up to complianceobligations they would rather not deal with; they

just want to trade.

Failure to convertThe objection to the strict compliance

regulations also extends to platforms that hadconsidered becoming SEFs. One international FX

trading platform that ultimately decided not tomake the move to become a SEF had estimated

the costs of doing so as in the millions of dollars.Wed need a new compliance and technology

team dedicated to this facility, separate from the teams we already have in place for the rest of the business, the head of the European arm of the platform tells Euromoney. It didnt makebusiness sense for us, he adds.

At a CFTC event in June, Wendy Yun, amanaging director at Goldman Sachs AssetManagement , stressed the importance of the

I know a lot of buy-side rmshave signed up for these rulebooks,I dont know why

Michael OBrien, Eaton Vance


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MARKET FOCUS


playing eld because those non-SEFs dont haveregulatory requirements, so Im competing withan arm behind my back.

Yet Burns understands why some potentialclients might be reluctant to join a SEF whenit comes to the FX market in any case. Someglobal corporations are trading FX because theydont have a choice, she says. They have globalpayroll obligations; they are collecting revenuewhere they are not headquartered and thereforeneed to repatriate that revenue back to theirhome currency. Its just the cost of being in thebusiness they are in. So they dont understandwhy they have to go through all these hoops just

to continue trading.However, the day is likely to come when

they will have to. Trading mandates are expected to follow. Unfortunately the road from this pointin the phasing in of SEF rules is far from clear.

Timings for new rules are still uncertain and as the CFTCs OMalia admits, there is much work to be done to correct mistakes in the rulesalready implemented.

International wranglingOne hurdle to overcome is the apparent lackof cooperation with regulators around theworld. A big concern for the market participantsEuromoney spoke to concerned the clearingmandate for swaps, and how timing andcoordination on this front would work.

The CFTC has indicated it might introduce

mandatory clearing rules by the end of this year,says Best. So now we are beginning to thinkabout how we will accommodate execution-level requirements in a very real way. We have anelectronic NDF platform, but we need to focuson how we get permission for access acrossother regulatory jurisdictions.

Burns says of the clearing mandate: Thisis still a work in progress. There are some verybasic operational issues that have yet to be madecrystal clear, which is an additional challenge foreveryone who is involved in the clearing process.It is hard to build systems because you dontreally know what your requirements are.

It is expected that in Europe the earliest that mandatory clearing will begin is the endof this year, and at the latest next summer. Thedeadlines are dependent on the EuropeanMarket Infrastructure Regulation, under whichclearing and the authorization of clearing housesare regulated.

Reppas thinks participants might already be testing their processes on SEFs. We are nowseeing a trend of European investors tradingincreasingly on the SEF, he says. The reason is

that more and more clients are starting to clear their index positions. Here in Europe we willhave the clearing mandate very soon, so theseclients are preparing for that and the perfectvenue for them to try these things is on the SEF.

Unfortunately there is no sign of a realeffort to ensure that the US and European ruleswork in harmony to allow ef cient clearing ofinternational trades.

Coordination between internationalregulators has been at times dif cult. An exampleis the apparent collapse of the negotiationsbetween the US and Europe over quali ed

multilateral trading facilities (MTFs), an agreement that could have allowed swaps traded on theEuropean equivalent of SEFs to avoid much of

the pain of the Dodd-Frank Act. Nevertheless the commitment to providing rules that canco-exist without market disruption does seem

to be there.Mi d II [European nancial market

regulations] will deliver the G20 mandate toincrease trading of standardized derivatives on

transparent venues, says David Bailey, the UKsFinancial Conduct Authoritys head of marketinfrastructure and policy. Esma [the EuropeanSecurities and Markets Authority] is currently

seeking the markets input on the detailed transparency rules and liquidity criteria that willsupport this new framework across Europe.Key to the success of the new European ruleswill be the way that they interact with otherregimes. The Mi d approach is fully consistent

with international principles agreed by IOSCOin 2011, and I welcome continued closecooperation between regulators of the majormarkets.

In the meantime, market participants arecarefully monitoring regulatory progress around

the world and trying not to worry.For the buy side, with exposure in Europe

and the US, the lack of alignment between the MTF rule and the SEF rule is de nitely aproblem, says Zohar Hod of SuperDerivatives.Luckily Im a software provider so it doesntbother me at all.

Reppas says: It is a concern thatinternational regulators seem not to be workingwell together.

Best says: Ultimately the new regulations[globally] have their origins in the same place.And therefore we are pretty optimistic thatwe can make the rules reconcile and continue

to achieve a global liquidity pool. Thats not tosay that we arent tracking developments verycarefully.

Fitzpatrick believes IOSCO could have beenmore in uential in the process of developing

these rules. IOSCO should have taken a moreaggressive management role in the globalstructure and cooperative implementation of allof this, he says.

No answersAnd its not just conversations betweenregulators that seem to be going awry. Marketparticipants report frustrations when asking forclari cations on the rules in the US. One seniorplatform representative who did not want tobe identi ed said the temptation was there tosimply wait for the rst round of enforcement

actions to give some clarity on the complexrules.

But others report better experiences when talking through rule problems with those whocreated them. In talking to the CFTC I amalways pleasantly surprised by just how open

they are to discussion, says OBrien. They aremaking a real effort to understand the concernsof the market. Of course, it doesnt always mean

that they will agree.Others acknowledge the size of the

challenge rule-makers face. I think the reason that people cant get answers to questions isbecause the people they are asking genuinely

We will assess marketconditions and work closely

with our customers to ensure ouroffering meets their needs

George Harrington, Bloomberg


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MARKET FOCUS


dont know the answers and are still guring itout, says Burns.

Weve asked for guidance on certain thingsfrom the CFTC, says Reppas. I realize that over

the last year they have been swamped; theyvehad a lot to do. They have done their best to

respond to our questions but they have beenunder-staffed.

For Icap, direct conversations withinternational regulators are going well. Earlier thisyear the rm launched Icap Global DerivativesLimited (IGDL), which is both a SEF and anMTF, meaning it is currently already regulated byboth the CFTC and the UKs Financial ConductAuthority (FCA). But thats not the end of theprocess. We are seeking permission to operatein Asia and Latin America, which will take time,as it does everywhere, says Best. We have toapproach the authorities and seek licences tooperate. It is dif cult to know how long it will

take to get approval. Wed like to be global assoon as possible.

Data dif cultiesOne of the hottest topics to address, as theSEF rules are adjusted and platforms look togo global, relates to the collection of data. TheCFTC is open about the fact that it is currentlynot receiving adequate data about trades onSEFs. In the Euromoney poll most respondents

said they did trust the data being gathered. Butmarket participants, not to mention the CFTC

themselves, know more needs to be done.The CFTC needs to issue some guidance to

clarify what was intended for the data reporting,says Burns. Thats the purpose of guidance.

Reppas adds: There are many differentplaces you can report to under the rules. Therules were not prescriptive enough and nowdirect comparisons cannot be made. Thatssomething we are faced with when we are trying

to see what our market share is. Were going through all the websites and trying to convertdata so we can see how our products are doing.

He says that the market has recti ed theproblem itself to an extent, with some informalconventions having been established to offermore uni ed data.

But when it comes to the physical rules,crucial points such as the currency in which

to report notional volume for FX trades, forexample, are not speci ed. And when it comes

to making comparisons between SEF andinternational SEF-type platforms, forget it.

Consolidation soon With the market slow to take off, talk of mergersand acquisitions has begun. There has been

turnover at the top of some SEFs and others that submitted registration papers to the CFTCappear not to be actively trading. They have

perhaps decided the market wasnt worthy offurther investment, or possibly failed to attractclients.

Customers are sticking with names theyknow when it comes to choosing a SEF, saysFitzpatrick. When there is that much risk in themarketplace you dont increase it by going to avenue that didnt exist six months ago. Start-upSEFs have the mother of all uphill battles.

Burns agrees that the newcomers have anincredibly challenging task. Thomson Reuters

is successful because we already had a liquidplatform and we just had to layer the SEF likean outer shell. We didnt have to compete fornew liquidity, she says. We had an existingcustomer base, and we simply had to convince

them to continue using our platform with its newregulatory outer shell.

A brand new SEF has to not only developsurveillance capabilities and technology thatis robust enough to pass CFTC investigationsbut also has to convince customers to take a

regulatory requirement that nobody wants. Thatsa very tough sell.

Reppas says: Were already seeing someof the start-ups facing some dif culties, the dataspeaks volumes. We wouldnt be surprised to seesome consolidation among SEFs in the comingmonths.

Hod says: I think there is going to be moreand more adaptation [to trading on SEFs] but itsgoing to be very, very slow and its going to besurvival of the ttest. I believe well see a ight toquality, only the strongest SEFs will make it.

Most of those Euromoney spoke to say they

expect consolidation, Icaps Best predicts that themarket might ultimately shrink to just four SEFs.He says: SEFs have been going since Octoberlast year; for both customers and SEFs there arecost pressures relating to on-boarding and doingbusiness. There are also considerable additionalcosts to run a platform as a SEF. I think peopleare beginning to evaluate whether its worthbeing a SEF anymore. Some will get consumedby others, others will disappear altogether.

Fitzpatrick says: SEF rules will concentrateliquidity, which isnt bad so long as you dontconcentrate it too far. Youll see very little liquiditymoving downstream; it will be moving up to the

The most important thing is to get the clearing part sorted, says Reppas. Most people who arethinking about joining a SEF probably arent currently clearing their products; theyre doing bilateraltrades. They need to do all the relevant due diligence and get familiar with clearing.

Hod adds: One of the major effects of this legislation is that clearing is no longer an afterthought. Thetrader has to think about where he is going to clear before he starts to trade.

Advice for newcomers to SEFs CLEARING

We are beginning to thinkabout how we will accommodate

execution level requirements

Peter Best, Icap SEF


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MARKET FOCUS


successful.Reppas notes that the buy side is learning

by doing, with the hedge fund communityleading the way as active clients and more

traditional asset management rms still trying to adjust their processes. On quieter trading

days you see buyside rms experimenting, hesays. We regularly see clients trading throughour anonymous protocols. Many of which, after

the transaction is done, will question us for thecounterparty of the trade. They simply cannotcomprehend that they could trade anonymouslywith someone else. Its a learning process, weregetting there.

Talk to meIts not just better communication with clients

that needs to take place. SEFs and the buy sidealike want to see a coordinated effort to talk to

the CFTC about their concerns over these rulesand the scale of the changes taking place.

This is a radical shift to market structureand these things cant be done successfully

overnight, says OBrien. The buy side needs to be more vocal about what they think. Thereare fewer banks; they can organize themselvesmore easily. For the buy side you have big rmslike BlackRock, Fidelity and Vanguard, you havenimble hedge funds, middle-sized funds and so

on. There are some trade groups representingparts of the market, but the buy side generally isnot well organized. I dont know if by the end of

the consultation process the same message wasgetting through from the buy side to the CFTC.

Burns says: We think there should be anindustry conversation about how data should bereported. We all have a vested interest in havingapples-to-apples comparisons made; we all want

to be judged on market share. So lets have aconversation to agree on that.

Many other SEFs were keen for this tohappen, including MarketAxess, Icap and Tradition.

We would be interested in being involvedin an industry discussion about how data shouldbe reported. says Fitzpatrick. But I dont think

the SEFs should be the ones to decide what is

reported. How and the uniformity of it we canhelp with.

However, there are problems facing this,as Burns notes: [Unfortunately] Theres nomechanism for having that conversation. If I were

to call the other SEFs to talk about this, it would

be seen as collusion.Despite all the troubles getting to this stage

of the process of introducing SEFs, and theundoubtedly bumpy road ahead, there are signs

things are improving. Trading data is starting topick up and interest from around the world isgrowing as market participants accept that theserules are here to stay.

These rules arent going away and they aregoing to change day-to-day business whetheryou like it or not, says Burns. Just get on withit. You can rile at how silly this or that is, but itwont change anything. You need to gure out away to minimize pain, serve clients better, and

nd the upside to regulation, because it is notgoing away.

Euromoneys research, rankings and awards have a unique

reputation for independence, credibility, global reach and integrity. Now, you can use Euromoney Research Group to understand betteryour businessand your clients needs.

PULSE SURVEYSGain insight and promote thought leadership through our snapshot polls of marketparticipants. BESPOKE RESEARCHGeared directly to bank/client needs and delivering actionable insights to help grow yourbusiness. MARKET INSIGHT REPORTSCombining the best of Euromoneys research and editorial output to produce de nitive data/ analysis/guides. ANALYTICS The full suite of analytical products from our benchmark surveys providing quantitative andqualitative data.

Tim Moxon, Publisher, Euromoney Research Group T: +44 207 779 8694 E: [email protected]

Catherine Snowdon, Editor, Euromoney Research Group T: +44 207 779 8288 E: [email protected]


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SEF SURVEY RESULTS: FX MARKET


Trading on SEFs in the FX market hasunderstandably got off to a slow start. After all,not many instruments are available for trade

this way. The concept was simple: under theDodd-Frank Act, in order to promote market

transparency, certain over-the-counter derivativesproducts must be traded on a SEF and cleared

through a central counterparty. In the FX market, the instruments rst brought into this regimewere options and non-deliverable forwards(NDFs); others are expected to follow.

However, many market par ticipants arechoosing to trade off-SEF. This was clearly shownin the data gathered for this report. Less than

a third of those who took the survey said theywere trading FX on a SEF.

The CFTC envisaged a market wherecompetition was high and participants had a

choice of platforms and access to the verybest prices as a result. Our research has notfound this. Just one respondent is trading on

ve or more SEFs. The majority prefer to

choose just one platform to partner with. Ourimpression is that most market participants at

this stage seem to be testing the market; morelikely not willing to go through the hassle andexpense of on-boarding with any others aftergoing through the process once.

Data available from the Futures IndustryAssociation and other publicly available sourcespoint to a handful of SEFs dominating in the FXmarket. This was very much supported by theresponses to the Euromoney survey, which show

that Bloomberg, FXall, Tradition and GFI Group topped the poll.

It is fairly clear from our research that there will be a slow increase in the volumeof FX trades, but this is not likely until moreinstruments are made available to trade. Whenasked how market participants expect theirvolume of FX trades completed via SEFs tochange, on the whole the responses pointed

to increasing volumes, but slowly over the nextyear, with a bigger jump in the coming ve years.It is possible the market is following the widelyheld expectation that more FX instruments willbecome available for trade on SEFs, or that astrict mandate will be introduced during thatperiod.

Slow market adoption to continue Participants choosing to trade on one SEF only undermining hopes for a market brimcompetition Volumes are expected to increase less over the next one to two years; increases seen asaccelerate over the coming two to fve years

SEF survey results: FXKey points

SEF SURVEY RESULTS: FX MARKSEFS STRUGGLE TO GAIN TRACTIO

Now One year Five years 10 years

0

10

20

30

40

50

%

Expected percentage of FX volume traded on SEFs

Source: Euromoney Research Group


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SEF SURVEY RESULTS: IRS MARKET


Early in 2014 various types of interest rateswaps became mandated to trade on SEFs.As a result this market is seeing very differentuptake of trading on SEFs compared withFX. However, given the international reach of

this Euromoney report, we had a number ofresponses from people who are not trading onSEFs. What they had to say is interesting and at

times shocking.One respondent from China said that while

at the moment using SEFs was not necessary,when trading interest rate swaps in currenciesother than renminbi, not using the facilities mightprove inconvenient in the future.

For Europeans, the decision not to use SEFswas straightforward. We only invest in euros. Wecomply with European regulation, said one. Our

company is based in Europe; we dont trade USswaps, said another.

A Japanese respondent said quite simply that the reason he isnt trading on a SEF is because the installation of SEFs is not required by theauthorities in Japan.

For many it seems a black-and-whitedecision: until I have to, I wont. For US personshowever, or those wanting to trade with one,

that time is already here.

Bombshell reasons for trading off-SEFSEF providers and regulators might be

concerned by some of the responses from thosestill avoiding SEFs. Some have ceased trading SEFvehicles altogether since the regulations becamemandated, nding other ways to carry out theirbusiness. Even more worryingly, one says he

trades over chat services on Bloomberg. Thatworks ne, so we see no reason to change

that, he says. In the light of recent events in theFX market and the impact of chat rooms (onservices such as Bloomberg), though, banks mightbe loathed to continue this practice (many havealready stopped).

Lack of instrument coverage was alsohighlighted as a reason to stay away from SEFs.

One European respondent lamented not beingable to ef ciently trade structured IRS swaps

[or] trade packages on SEFs.Other international respondents indicated

that the volumes they trade do not support

making the move. One said his company lacked the internal systems to shift and [we] dont do

enough volume to justify [investing in them].We are a small company, we have a small

fund management operation that does not

SEF SURVEY RESULTS: IRS MARINTERNATIONAL PLAYERS SLOW

Bigger increase in volumes traded on SEF expected over two to ve years than in the two years International interest in trading on SEFs is growing but educational efforts must contin Majority trading on one SEF only; leading to concerns for competition Trades are still happening over chat functions, side-stepping the tighter SEF regulat

SEF survey results: IRS Key points

Geographical breakdown of IRS survey respondents



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SEF SURVEY RESULTS: IRS MARKET


require the use of professional tools, saidanother.

Why choose to shift to SEFs?Peer pressure was suggested by one respondentas being the reason his company would

start trading on SEFs. If more and morecounterparties need to trade IRS on SEFs, itseems we must choose one SEF to continue

trading. The speci city of choosing a lone SEFwill interest the market. From the start, the hopehas been of creating a marketplace with as muchcompetition and choice as there had alwaysbeen. But if the arduous process of on-boardingand slow uptake from the buy side means thisisnt possible, we could end up with a monopolyof a very small number of SEFs.

Others pointed to regulatory change asbeing the only thing that would make them

trade on SEFs. Introduction of mandatory useof SEFs in Europe, was the only way to get onerespondent interested.

Others wanted to see reliability,convenience and better prices from SEFsbefore making the move.

Greater exibility [and] meaningful liquiditybene t leading to changes in portfolio structure,said another respondent.

We see the potential need to trade SEFmandated vehicles in the future, but are notinterested [at the moment], said a US market

participant.The transparency of trading this way was

highlighted as being an attraction, with one

prospective SEF client saying he thought it wouldprevent a mistake of order.

Many still choosing to trade off-SEFAs with the FX market, we found the majorityof respondents are yet to trade on SEFs. This

was unexpected in the IRS sector, as certaininstruments have been made available to

trade, which means they have to be traded onSEFs. However, the answer lies in where ourrespondents are based. As the map shows, weheard from people all over the world, many ofwhom will not be touching the US market, and

therefore the Dodd-Frank rules.In terms of market competition, we were

concerned to discover that most marketparticipants, even in the more mature IRS market,are using only one SEF. It is possible they trialledothers before settling on their favourite; morelikely they went to the biggest players, or reliedon existing relationships when the rules came in.This suggests that start-up SEFs might nd it hard

to compete, which can only be bad news for the market in terms of encouraging innovationin products and technology. Struggles withinnovation were highlighted in the FX survey asbeing a big hindrance to newcomers wanting to

join the SEF trading world.

Five-year expectation for notableincrease in volumes

There was a strong majority in answer to thequestion about how the percentage of volumes

traded on SEFs would change in the coming

No: 75%

Yes: 25%

Are global SEF-type rules possible? (IRS respondents)


Yes No0

10%

20%

30%

40%

50%

Did the introduction of SEF rules have a cost for your business? (IRS re


years. Market participants clearly expect to see these increase, presumably as more and more of the market becomes mandated.

There was a bigger change between theposition now and in ve years than in the next12 months, indicating a prolonged adoption

period of this way of doing business.Respondents noted little impact on their

business by the change in rules, with just onesaying the introduction of SEFs had had anegative impact. And in further good newsfor the SEFs and their educational efforts, themajority were not confused at all about theprocess of shifting to trade on SEFs.

International rules a no-goFX market respondents said they thoughtinternationally agreed rules might be possible.Not so for those responding to the IRS survey.The more experienced IRS market gave aresounding no answer, demonstrating theirunderstanding of the dif culties.

Three-quarters of respondents said they trusted the data being gathered about tradingon SEFs. And the same proportion expected nochange to volumes of trade being concentratedon a small number of SEFs.

When it comes to cost, those trading IRS ina mandated environment more often saw a cost

to their business and they also predict a rise incosts over the next ve years. Perhaps it is a

sign of what is to come for the FX market asand when more instruments are made available

to trade.


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Documents

SEF Market 2014 - Euromoney