UPDATE: CFTC Pledges To Promote Competition Among Swap Trading Venues

By Katy Burne



The chairman of the Commodity Futures Trading Commission said regulators will ensure that a new type of derivative trading venue called a swap execution facility would have equal access to clearinghouses, reassuring start-ups that their interests will be safe.

Speaking at the Wholesale Markets Brokers' Association Americas conference on swap facilities in Washington on Monday, CFTC Chairman Gary Gensler said he wanted all swap execution facilities to have "impartial access" to all clearing venues.

The need for these new derivative trading venues was brought about by the Dodd-Frank Act, the financial regulatory overhaul sponsored by Sen. Christopher Dodd (D., Conn.) and Rep. Barney Frank (D., Mass.). It calls for mandatory trading of certain derivatives on national securities exchanges or alternative execution facilities, now known as SEFs.

In particular, it focuses on trades that are standardized enough to be guaranteed by clearing houses, including generic interest-rate swaps and index credit default swaps. The ultimate goal is to increase transparency and achieve better pricing for corporate end-users of derivatives.

Just like exchanges, swap facilities will need post-trade links with clearinghouses, which safeguard each party in a trade should a counterparty become insolvent. But some industry participants said they worry big exchanges could smother smaller rivals by offering discounts for trades executed and cleared through an exchange-backed venue.

Chris Ferreri, Managing Director in hybrid trading at Icap North America, a broker of derivatives between dealers, told attendees that firms seeking to enter the market were worried that competitors who earn fees on execution and clearing could reduce their execution fees to zero and push execution-only firms to the sidelines.

Gensler said he wanted to restrict such conflicts by giving all swap facilities "impartial access" to all clearinghouses, and even to other swap facilities, in case orders had to be routed to another platform.

Darrell Duffie, professor of finance at Stanford University's Graduate School of Business, said that impartial access might be challenging. "Despite regulations that may preclude some SEFs from discriminating," Duffie said in an interview, "it might not be that difficult to set up some barriers to execution facilities that are not affiliated...There are lots of technical impediments you could put in someone's way."

The CFTC estimates as many as 30 to 40 could register as swap facilities and around 200 could register as swap dealers. The regulations are set to be in place by July 15 and to be enforceable 60 days later. The mandatory trading over exchanges or swap facilities does not apply for trades that are not required to be cleared.

All of the Wholesale Markets Brokers' Association Americas members have stated their intention to register as swap-execution facilities and inter-dealer brokers are seen as a natural fit for that designation.

But it's unclear if they would need to register for each eligible platform in a single company or if many facilities within the same company can be covered under one umbrella registration. It is also unclear whether in the pursuit of ultimate transparency, interdealer brokers will have to open up their platforms to non-dealers.

IntercontinentalExchange Inc. (ICE) has expressed an interest in registering its interdealer broker Creditex and possibly another new platform as swap facilities, and CME Group (CME) "is creating its own SEF if appropriate," according to a spokesman.

The statute defines a swap-execution facility as something other than a designated contract market or exchange, and something that facilitates swap execution. They also must let "multiple participants...to execute or trade swaps by accepting bids and offers made by other participants."

In some ways that definition is very specific but in other ways it is vague. What it means is that regulators want to see that several customers in a trading venue have access to quotes from several competing banks. "It is not a facility where many buyers have access to one dealer," CFTC's Gensler said at the conference.

What it doesn't say is whether swap facilities are required to ensure customers see multiple quotes from liquidity providers--that is, banks--individually, or whether they should be allowed to see each others' quotes simultaneously. Regulators and over-the-counter derivatives dealers still needs to hash out such key details.

Wall Street dealers charge one another less than what they charge their customers. They also use a price-quote system that keeps the terms of their trades with customers private. That way they can build in extra costs for counterparties they consider risky or infrequent buyers, for example.

Many banks use a proprietary system to distribute prices to customers. If new rules let customers see competing prices from multiple dealers simultaneously, it will only be a matter of time before the banks lose the lucrative spread between bids and offers.

Bankers aren't the only market participants fighting over market transparency. Institutional buyers are concerned about competitors knowing what it cost them to enter a trade because it could make exiting the same trade more costly, or it could force them to have to break their trade down into smaller chunks creating more work.

Some have been calling for a tiered system where data reporting on the size and price of a trade would happen differently for an algorithmic trading firm getting in and out of positions quickly than it would for a pension fund doing a large block trade it needs to hold onto for risk management purposes.

"If we do this wrong, we'll hurt liquidity and not achieve the policy objective" of best pricing for customers, warned Athanassios Diplas, global head of the systemic risk management group at Deutsche Bank (DB, DBK.XE).

Examples of existing RFQ models include Tradeweb and Bloomberg. New swap execution facilities include dealer-backed Javelin for credit default swaps and interest rate swaps, and E-Deriv formed by ex-Goldman Sachs executives for equity derivatives.