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Fragmentation Coming to a Swaps Market Near You

Fragmentation is coming to the swaps market and dealers are preparing to spend heavily to build systems that can aggregate liquidity for their buy-side clients, according to a report by Tabb Group

Fragmentation is coming to the swaps market and dealers are preparing to spend heavily to build systems that can aggregate liquidity for their buy-side clients, according to a report by Tabb Group. Although the final rules that will govern the swaps market under the Dodd-Frank Act haven't been passed yet, swaps dealers intend to spend $504 million to create, implement and market the aggregation platforms that the buy side will eventually need, the research firm said.

Historically, the combination of new regulations and available technology creates an environment in which liquidity fragmentation across multiple trading platforms is inevitable, the report said. It also pointed out that such conditions currently exist in the $600 trillion global swaps market.

The coming changes to how swaps are traded under Dodd-Frank means platforms that can tap the best liquidity sources will become a necessity for the buy side, the report added.

"Whether there will be three or as many as 10 SEFs (swap execution facilities) per asset class remains unclear, but finding the size you need at the right price will become less about who you know and more about the quality of your aggregation technology," Tabb Group analyst Kevin McPartland said.

But even as dealers are preparing to invest heavily in order to offer the buy side tools to trade effectively in the new landscape, they're facing a number of significant hurdles. Because although liquidity aggregation in markets like equities and FX is common, creating SEF aggregators and advanced smart order routers for the swaps market will be much more challenging than it is for other assets, the report noted.

"Aggregating request for quote (RFQ) and order book markets into a single view is no easy feat," the report said. "Automating the inherent complexity of an experienced swaps trader's decision-making process will require technology that's akin to artificial intelligence."

The report also noted that even if intense lobbying or the election of a Republican to the White House in November prompts a shift in the rules, the swaps market will still fragment.

"The need for SEF aggregation is serious and it's not going away," McPartland said. As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio

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