The New World of Swap Execution: Timelines for SEF Preparation

At a DerivSource webinar, speakers discussed the recently finalized CFTC rules on swap execution facilities (SEFs) and offered insight into the coming adoption and compliance timelines that market participants should be gearing up for.

In May the US Commodity Futures Trading Commission (CFTC) published final rules on SEF registration and oversight and on the process under which SEFs or designated contract markets (DCMs) may make a determination that a particular swap is made available to trade (MAT), i.e., subject to mandatory trading on only a SEF or DCM.  The CFTC actions provided much needed clarity on how the new world of swap execution will operate.  However, now market participants and trading platforms face a tight timeframe to make the necessary adjustments required to support electronic execution of swaps via SEFs.

To recap, the SEF rules that were finalized in May include: block trade rules for large notional off-facility swaps and block trades; MAT rules; guidance on anti-disruptive trading prohibitions; and final rules on SEF oversight, including  rules on the minimum required number of potential counterparties to be contacted in a request for quote (RFQ) for a swap subject to mandatory trading, which calls for a minimum of two counterparties  in RFQs for the first year and thereafter will be increased to three.  Also, the CFTC’s SEF final rules make it clear that any person operating a trading system in which multiple market participants have the ability to trade swaps by accepting bids and offers made by multiple participants must register as a SEF.  Conversely, those offering a trading system in which only one market participant has the ability to trade with other market participants do not meet the criteria to register as a SEF or DCM (for purposes of swaps not yet subject to mandatory trading), but have in effect been provided limited relief to continue operating until a MAT determination is made on a swap listed for trading on their system.

The new rules were published in the Federal Register on June 4, 2013 and specified that implementation will commence 60 days from that date, or August 5 2013 (the “Effective Date”). The Made Available to Trade and SEF registration rules will come into effect then and this will also initiate a compliance deadline of October 2 2013, after which many-to-many electronic swap platforms will either need to have registered as a SEF or must cease and desist – the “Compliance Date”.

Those who aim to become a SEF, such as State Street’s SwapEx platform, will be busy ahead of this August Effective Date prepping to set up platforms in accordance with the finalized rules, explains Tomas Zikas, Managing Director & Head of eRates Business, State Street.

Zikas said: “As the operator of SwapEx I will seek to file a registration document with the CFTC prior to the Effective Date so we can be listed in the CFTC’s initial group of provisional registrants. There are going to be other SEF candidates that are equally going to jump into that first tranche of SEFs. This will be a good indication of which SEFs you probably need to start looking at as they have prepared a full registration with the CFTC and are self-certifying their conformance with the regulations as they prepare to move forward.”

The period between the Effective Date of August 5 and the Compliance Date of October 2 can be viewed as the adoption period when practical steps will need to be taken to adopt to your chosen SEFs.  As noted, by the Compliance Date, electronic trading platforms providing matching services in derivatives must be registered as a SEF or DCM.  Any many-to-many electronic trading platform that supports the matching of swaps must be registered and in compliance by this Compliance Date. 

This makes for a relatively tight total timeframe for SEFs to get up and running and for market participants to be ready to trade electronically via these new execution facilities.  A first step for market participants is the evaluation of the SEFs that are available, and there are a number of practical concerns that participants will need to address as they consider their initial SEF destinations, explains Zikas.

He said: “When vetting your SEF destinations (which are only provisionally registered and self-certifying compliance), each customer may want to consider conducting its own due diligence  to make sure that the SEFs they intend to use are in fact in compliance with regulatory requirements. This requires knowledge about what is “Minimal Functionality” (i.e.,  central limit order book or, for RFQ platforms, RFQ plus a central limit order book), is the compliance monitoring regime of that SEF adequate, what does the rule book say this SEF will do and are the supported execution styles in conformance with your interpretation of the rules.”

In terms of the asset classes that are likely to be made available for trading first, and thus subject to mandatory trading, the expectation by the webinar speakers is that the first category will likely include interest rate swaps and credit derivatives.   By statute, the mandatory trading determination necessarily must follow after an initial mandatory clearing determination by the CFTC.  Due to the perceived lack of transparency in interest rate swaps and credit default swaps (CDS), the CFTC has prioritized mandatory clearing for these asset classes, which could determine the speed at which other asset classes move into trading on SEFs.  FX products, especially the non-deliverable forward (NDFs) FX business, have yet to receive mandatory clearing determinations, though they are likely to become subject to mandatory clearing sometime in 2014.  With regard to the mandatory trading of swaps, the anticipated timeframe date for the initial MAT determinations (and hence the first dates for mandatory trading on a SEF for the initial round of derivative instruments) could fall as early as December of this year.

Ricardo Martinez, Principal, Deloitte & Touche LLP’s Enterprise Risk Services explains:

“The development of compliance in other rules has seen the reporting to repositories of credit and rates first, followed by equities, FX and Commodities. The higher levels of liquidity in these asset classes are likely to enable potential SEFs to prioritize them. We have also seen a number of platforms getting ready to serve the FX derivatives market.”

With regard to the block trade rules, the final CFTC rules established two phases of implementation.  In the initial phase, the CFTC will prescribe appropriate minimum block sizes in the following five asset classes: interest rate swaps; equity swaps; credit swaps; foreign exchange swaps; and a general category of “other” commodity swaps.   In the later phase, the CFTC will switch to a different calculation for determining these block trade sizes.

The effective and compliance deadlines will come around quickly for derivatives market participants and at a time when there are various other Dodd-Frank related projects in progress, so time is of the essence.

State Street’s Zikas advises: “You should really start looking now at your internal adoption cycle, and the level of effort/resource (legal, compliance, technology) should not be underestimated.  Preparation today will help you avoid the inevitable log-jam as the mandatory trading dates rapidly approach”.

* The graph and article is for infomational purposes only and is not to be viewed as advice.