As Dodd-Frank reforms move forward, SEFs prepare for market share melee

By Adam Cox


The Dodd-Frank legislation that is overhauling the OTC swaps market is likely to lead to more potential swap execution facilities (SEFs) broadening their offerings and embracing a multi-asset-class approach, a study by GreySpark found.

The study considered the offerings of 52 potential SEFs, with a focus on what GreySpark considered the top 12. These 12 firms, which were chosen based on a number factors including size and product range, were BGC Partners, Bloomberg, Creditex, FXAll, GFI, ICAP, Javelin, MarketAxess, State Street, Tradeweb, Tradition and Tullett Prebon. Thomson Reuters recently struck a deal to buy FXAll.

"Presently, there are only a handful of true multi-asset providers, with many leaning towards a single asset class," the study said. "However, this will evolve in the short term (for SEF go-live) with many SEFs planning to broaden their product offerings."

Bradley Wood, a partner at GreySpark who presented the report at a round-table event, added that this trend did not hold true for all firms and that some will still decide to focus on a single asset class.

In terms of market structure, there was a trend towards high throughput, low latency electronic central limit order book (CLOB) trading for rates and credit, with quote-based functionality still important for dealer-to-client (D2C) flows and complex FX and credit products, GreySpark said.

Rates, FX and credit will be the dominant asset classes. The firm said that commodities and equities were the "laggards in the SEF market" and that volumes were likely to be low.

Some of the other main findings were that:

- all SEFs will support the requirment to handle unique product identifiers, unique swap identifiers and legal entity identifiers, rules which are designed to give regulators a better handle on what is happening in the market;

- venues will offer the widest possible choice of clearing houses, either directly or through third party platforms such as MarkitWire;

- smart order routing and market data aggregation will require an asset-class-specific response;

- in FX, the scope is limited to non-deliverable forwards and FX options;

- in rates, the emphasis is to cater for volumes across dealer to dealer (D2D) and D2C markets;

- and in credit, many firms are providing both order and quote-based functionality, and more advanced functionality such as portfolio compression capabilities are expected due to the nature of the market.

GreySpark said the trend towards CLOBs will be gradual. "What is most important is that as the evolution of the swaps market progresses, so banks will be forced to compete for smaller and smaller margins and lower and lower volumes per ticket, particularly for vanilla products with standardised contracts," the study said.

That in turn meant volumes would increase.

But with the lack of dark pools for larger trade sizes, there will still be a need for request-for-quote facilities. "Banks must plan for a swaps market that relies more and more on low latency, high-throughput technology stacks so that market share currently enjoyed in the OTC and voice-trading space is not eroded as the swaps market becomes more flow or agency-centric."

Interest rate derivitives are expected to be the most traded of all the asset classes mandated for SEF trading, with 50 percent of the current product in scope for SEFs already centrally cleared.

In credit, the report predicted that with capital adequacy rules in focus, OTC dealers will be less keen to warehouse corporate bonds. "This in turn will give way to a move from the traditional 'buy and hold' trading model and to a subsequent rise in trading," it said.

The study said SEFs differed in their views on pre-trade risk management. Many felt it was the function of CCPs to ensure counterparty credit risk was managed and that SEFs only needed to reject orders for members who defaulted on margin calls, a function some referred to as the "kill switch".

But others may differentiate their offerings by providing a range of pre-trade risk features including circut breakers, self-trade protection or fat-finger protection.

Wood of GreySpark offered one major caveat for the whole report. Much, he said, could depend on the U.S. presidential election.

Among the the firms the group spoke to, some believed it was still possible for important aspects of Dodd-Frank to be amended or discarded if a Republican-dominated government were to be elected. "Certainly, the conversations we've had have intimated that this is a view that will be taken, that 'Our organisation is not going to jump into this until after the elections.'"