The Commodity Futures Trading Commission certified the first made available to trade (MAT) submission by Javelin Capital Markets, pushing certain interest rate swaps onto SEF platforms, ushering in a new era for the OTC derivatives markets.
The move was expected by many swap participants triggering the start of mandatory electronic trading for interest rate swaps on SEFs or exchanges on Feb. 15, which many are calling D-Day.
“This is clearly a landmark event for the $400 trillion swaps market and is one of the largest structural events for any capital market in 20 years,” commented James Cawley CEO of Javelin Capital Markets, which operates the Javelin SEF LLC.
Javelin’s MAT certification starts a 30-day clock, that upon its expiration, will require the majority of swaps to trade on a SEF, such as Javelin along with other SEFs including Bloomberg, Tradeweb, MarketAxess, TrueEx, TeraExchange and ICAP, to name a few.
Yesterday, market participants attending a Tabb Forum conference, “Fixed Income 2014 Breaking Rates,” were waiting for the CFTC’s reaction, after a 90-day review period, which expired at midnight.
Though Javelin’s initial on Oct. 18 MAT submission included a broad range of swap maturities and sparked debate over whether the least liquid swaps on the curve ought to be included.
“We’ve looked at all the MAT filings, and we were involved with some of the industry comment letters. We wanted it to be more narrowed as possible to start,” said Amy Caruso, director, Babson Capital Management on Tabb Forum’s SEFs panel. “We wanted to gravitate toward electronic trading. We have all these pieces, and want to stay focused on vanilla benchmark rates and the on the run CDX,” said Caruso, referring to credit default swap indices.
The industry consensus was that the most liquid benchmark swaps should be listed first. Citing operational concerns and feedback from buy-side institutions, Javelin amended its MAT several times, narrowing the maturities to include the most liquid, 2, 3, 5, 10 year maturities, while keeping 7,12,15, 20 and 30 year swaps, that are not regarded as the most liquid, according to a source. The regulator's certification takes into account Javelin’s amendments.
This means as of Feb. 15, any swap “whether listed or offered by Javelin or any other SEF or designated contract market,” would become subject to the trade execution requirement either on a SEF or designated contract market (DCM), according to the CFTC’s announcement.
Some Questions on 'Package' Trades
However, the CFTC’s certification is not without controversy in that it included “package” transactions or multi-leg transactions involving more than one swap in the trade requirement.
Though it received many comment letters and requests from market participants not to include so-called “package transactions” — transactions involving more than one swap or financial instrument – such as a swap against a treasury bond future, the commission did not grant relief to market participants from the trade requirement.
“The Division clarifies that the inclusion of a swap subject to the trade execution requirement in a multi-legged transaction would not perse relieve market participants of the obligation to trade such swap through a DCM or SEF,” stated the CFTC’s announcement yesterday.
Another wrinkle is that a package trade can contain both MAT and non-MAT swaps, explained Jeff Maron, managing at MarkitSERV in an interview, which runs an electronic processing service for OTC derivatives. “A butterfly strategy with 3,5, 10 all spot and in theory are all MATed. The bigger issue with packaged trades is it could be a whole bunch of trades some matted and some off,” said Maron. “Some are done with treasuries,” he adds.
In an email follow-up, Javelin’s Cawley said the firm excluded packages from its MAT except for swaps vs. Treasuries, which make up 45 percent of the swap market. “To exclude those would exclude the entire interdealer broker market — because that’s how they all trade,” he wrote in the email.
Acknowledging that market participants will have operational issues around building transaction order entry and execution technology to facilitate the trading of such package transactions, the CFTC’s Acting Chairman Mark Wetjen has directed the agency to hold a public roundtable on execution issues related to package transactions. Based upon this public input, the division will consider whether and under what conditions to grant limited relief for package transactions to ensure proper implementation of the execution mandate.
However, some market participants are concerned about including “package trades” in the mandatory trading mandate, noting that the infrastructure is not yet built to handle certain functions.
Currently, “the infrastructure is ready for trading outright swaps, but no one is ready for packages yet,” according to Sunil Hirani, CEO of TrueEx, one of the 19 SEFs registered to trade.
“The infrastructure for processing, providing credit approval and doing risk assessment for packages as one atomic unit doesn’t exist. It would be prudent to wait for at least one part of the infrastructure to exist, prior to making packages available to trade,” said Hirani. According to Hirani, the problem is that pre-trade credit checks, risk assessment — none of that exists anywhere for multi-leg swap transactions known as packages. “You need to have all these [elements] before you can do these types of transactions in an automated fashion.”