NEW YORK & LONDON--(The Death of a SEF: The Coroner’s Report.”)--No one wants to be a SEF, a swap execution facility, which is an entity with no clear meaning, created out of thin air by the Dodd-Frank Act and left to the Commodity Futures Trading Commission (CFTFC) to define, says TABB Group in new research published today, “
“Transparency is not a panacea, but inevitable as gravity.”
TABB believes that the OTC derivatives market is going to change more dramatically than regulations require. If not, it’ll cease to exist, warns Adam Sussman, a TABB partner, director of research and the report’s author. “We’re now past the point of no return. The dealer community’s business model is imperiled. Confidence in over-the-counter (OTC) contracts is being eroded by the LIBOR scandal. Losses by J.P. Morgan’s CIO office put the Volcker Rule back en vogue. How many hits does this industry have to take before it waves a white flag? Some dealers are telling us that they just want to get on with the change, they just want to know what the rules are so they can adapt.”
Existing swap venues that plan on registering as SEFs will do so because there’s no way out of Dodd-Frank, says Sussman, but he points out, there is an alternative: designated contract markets (DCMs). They have existed since 1938 when the Commodity Exchange Act was passed. Under Dodd-Frank, the type of instruments that can trade on a DCM has been expanded to include swaps, in addition to futures and options, whereas SEFs only have authority to trade swaps.
In the report, TABB compares SEFs versus DCMs focusing on six issues: tradable products; membership rules; credit checks; margin efficiency; legal certainty; and core principles. “Many of the new rules, including those dealing with open access, have been written to favor the DCM over the SEF,” says Sussman. “Transparency is not a panacea, but inevitable as gravity.”
If the DCM is good for swaps trading, the question is why DCMs have not begun trading swaps since the passage of Dodd-Frank. According to Sussman, “The reality is that there are neither SEFs nor DCMs that trade swaps today. Among the 29 firms that have announced their intention of being a regulated entity for trading swaps, most have said they will be a SEF. But SEF registration approvals will not occur until 2013 and start-ups have been burning cash for up to two years.”
Although the story of the swaps market often begins with regulation, TABB believes that in the end it will be supply-and-demand that drives the most significant change. “The industry is managing to adapt to the challenging regulatory environment,” says Sussman. “Innovation will always outpace regulation and without meaningful changes to the market, no one will need swaps liquidity. What’s needed are transparency, open access to trading venues and the separation of execution and financing.”
Not all of these themes are exclusive to the DCM, he explains, because SEFs have been able to offer pre-trade transparency, order-driven trading protocols, open access and pre-trade credit checks. “But if they’re able to implement all these features, why wouldn’t they simply become a DCM?”
The 14-page report with 5 exhibits is available now for download by TABB Group Research Alliance Fixed Income clients and qualified media. For an executive summary, visit www.tabbgroup.com or write to firstname.lastname@example.org.
About TABB Group
With offices in New York, London and expansion to Asia-Pacific, TABB Group is the only financial markets research firm focused solely on capital markets, based on the proven interview-based research methodology of “first-person knowledge” developed by founder Larry Tabb. For more information, visit www.tabbgroup.com. In January 2010, TABB launched TabbFORUM, the online global capital markets community covering analyses of current issues, tracked daily by nearly 13,000 professionals.