Monday, November 18th, 2013
After being the first Swap Execution Facility (SEF) to formally submit its Made Available to Trade (MAT) application to the Commodity Futures Trading Commission (CFTC) on October 18, Javelin SEF has also become the first to alter its application, reducing the maturities and types of swaps it had claimed should qualify for MAT status.
A recap for those of you that have not been following the story so far: Three SEFs – Javelin, trueEX and Tradeweb – have made their interest rate swap MAT submissions to the CFTC; Javelin was the first and had the most wide-ranging approach. The CFTC has allowed SEFs to self-certify MAT swaps, meaning they would be subject to mandatory trade execution requirements such as clearing, and therefore would fall outside the remit of other venues that trade on a more over-the-counter basis. What Javelin did straight out of the traps was apply the rules in a wider sense, with contracts covered both by request-for-quote and limit order books, including by phone. Its submission comprised swaps in the US dollar, euro and sterling across maturities of one to 51 years. This also included forward starting swaps and amortizing (or variable notional) contracts. Now the SEF has kicked out variable notional swaps and restricted forward-dated swaps to 10 months out, while the maturities of the contracts covered now only extend to 31 years, bringing it closer to submissions made by the other SEFs.
Javelin was the first to move, and so didn’t have the luxury of making a comparison with the approach taken by others. This may just be a natural part of what is a very public process that will determine the future shape of the market. After all, the final result may not be fully implemented until February or March next year (the Javelin application had an official review period ending on Jan. 19, 2014). Javelin, for its part, said in a release published overnight that it was “pleased to have sparked the debate and to adopt a more scaled approach for product offerings on its platform.”
Even after the changes, however, the result may still be worrying for some. Conversations with market participants as well as comparisons with the other submissions to the CFTC seem to point to an emerging consensus that what should initially qualify are the most liquid contracts at the most traded points of the curve. Tradeweb’s submission this week proposed 10 points between 2 years and 30 years, while trueEX’s US dollar submission covered eight.
Some of the confusion comes down to the way the CFTC formulated the rules in the first instance. SEFs have to prove eligibility under “one or all” of six criteria, and under the widest interpretation it would be very difficult to reject any contracts out of hand. Indeed, in its original submission, Javelin argued that variable notional swaps (along with other “class 3” swaps) should be covered because they derive liquidity from the basic instruments and dealers that make markets in one also quote prices for the other.
Some on the buy side were already skeptical of the blanket approach. There have been suggestions that the onus should really be on the SEFs to prove that, as an entity, they are able to make markets in any contracts they submit. That could be in the form of restricting submission to those that can be offered electronically on limit order books or that are supported by specific dealers. Those arguing for a much wider application can reasonably say that the CFTC never restricted modes of execution in that way, and it is down to the regulator to respond, not the SEFs themselves. Such an approach would go a lot further than the current test proposed by the CFTC, which itself has asked for public comment on the submissions.
Chairman Gary Gensler, who steps down at the end of the year, last night conceded in a public speech that the CFTC is overburdened and under resourced. After the US budget shutdown, it is hard not to have sympathy, but clarity is needed. How will the CFTC treat the submissions? Will it be on an individual or group basis? Most of the submissions are focused on the general market for various contracts, but will the commission also look at the institutions themselves and their ability to make markets? We have reached the implementation phase of a transformative process for the market, so there may well be no right or wrong answers here; but it is clear that answers are needed.