At yesterday’s swaps industry conference, US Commodity Futures Trading Commission Chairman Gary Gensler jolted the swap execution facilities (SEFs) with news that they must open up their platforms to all market participants, and not allow dealers to restrict trading partners.
The swaps regulator had already dropped the bombshell on Friday night with a clarification and no-action letter it issued on the ‘mpartial access rule. This means the three largest SEFs , Market Axess, Bloomberg, Tradeweb , that operate request for quote models (RFQ), allowing dealers to permission (a.k.a. select) which counterparties they will trade with based on their credit relationship, will have to change their platforms to be “all to all. “
“Bringing access to the entire marketplace means platforms will no longer be just dealer to dealer or dealer to customer,” said Gensler. He added, “SEFs are required to provide dealers and non-dealers alike the ability to view, place or respond to all indicative or firm bids and offers, as well as to place, receive, and respond to RFQs.” Currently, non-dealers can view prices if they submit a request for quote to two dealers, and next year it will be three dealers, based on the SEF rules finalized in late May. But the CFTC sees this model as restricting access to swap bids and offers. “All market participants should feel confident that their bids or offers are being communicated to the rest of the market.
Last week’s guidance was meant to address questions that market participants had brought to the Commission’s attention “as contrary to impartial access,” said Gensler in his address at the SEFCON IV conference in New York, an event sponsored by the Wholesale Market Brokers Association.
According to rumors, the regulatory shift was a result of complaints from large hedge funds, including Citadel, DRW Trading Group and Infinium Capital Management, seeking to participate as market makers on the new SEFs. Buy side firms, including the likes of Pimco and Blackrock, could theoretically trade with one another on SEFs, ending the current practice of dealers pre-selecting which asset managers and hedge funds can see and react to their prices on electronic swap trading venues.
At SEFCON, the CFTC’s guidance stirred up debate. “We’re moving through a very different model in terms of impartial access. It is an enormous change for the industry and I’m certain that not all SEFs are ready,” commented Richard McVey, CEO of Market Axess, who spoke on a panel at Sefcon IV.
While many in the market knew that an all-to-all model was coming in the future, they thought they had more time. CFTC Commissioner Scott O’Malia who moderated the panel, said: “I think everyone expected this to be an evolution to all –to-all and to have it be implemented abruptly it’s a surprise to all.”
SEFs Reaction: According to a Bloomberg News story, Market Axess indicated it would change its functionality to comply with impartial access, while Tradeweb conveyed it would continue to dialogue with the CFTC regarding Friday evening’s no action letter to ensure that it’s systems are in compliance. Bloomberg’s SEF also indicated that it was reviewing its systems to ensure that it remains in full compliance.
Analysts reacting to the latest SEF clarification seem to agree that the new guidance also applies to the IDBs, like GFI Group, ICAP, Tradition and Tullet Prebon, which match swap trades between the dealers. Some of the large buy side firms would like to get access to the IDB market prices, and contend it’s unfair that the dealers in the D2D space get tighter bid-offer spreads, noted an industry source. “Now it seems interdealers will no longer be able to maintain a market solely for the benefit of dealers,” wrote Will Rhode, Tabb Group principal and director of fixed income research in a commentary. Though IDBs cater to dealers, expanding their market to include asset mangers and hedge funds would put them in competition with their dealer customers who are liquidity providers on DtoC platforms. “Given their liquidity and price discovery skills they demonstrate in swaps, IDBs could have a significant advantage over the D2C platforms in competing for buy-side market share,” wrote Rhode in the commentary.
The question is will buy side firms want to go in market formerly known as interdealer? asked Kevin McPartland, head of market structure research at Greenwich Associates in his Kevin on the Street blog. “Adjusted for trade size, there still exists a spread between the prices in the interdealer market as compared to the prices in the dealer-to-client market. The more sophisticated clients, and soon many other clients, will want to recapture that spread,” wrote McPartland. While the CFTC's guidance will accelerate the move to an all-to-all offering, startup SEFs had already talked about this aspect as being important to Dodd Frank. “New entrants like Tera, Javelin and TrueEX are fine (and in many ways just had their models validated), as this has been their long standing approach,” wrote McPartland.
Meanwhile, the CFTC's revised interpretation of impartial access will bring more work to the SEFs whose IT staffs are working long days and weekends to meet compliance deadlines.