SEFs and OTC Trading special report

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Much Ado About SEFs

Love them or hate them, swap execution facilities (SEFs) are here to stay. Although the "Big Bang"-predicted to transpire in February, when certain instruments had to be executed electronically-never really happened, derivatives trading reform has had a profound impact on technology, market structure, and the international conversations about finance. Indeed, the establishment of SEFs is just the first stage of this change, with Europe now beginning to work on its own version of electronic execution in the form of organized trading facilities (OTFs), and some parts of Asia-Pacific beginning to consider the future of the market in light of mandates from the Group of 20 nations.

The build-up to SEFs and their birth hasn't been easy and the range of opinions on their practicality and usefulness is still diverse among participants. Privately, some senior figures in fixed-income trading say they see SEFs as simply reporting by another name, while others say the fight to make regulators understand that not everything can trade like equities has been exhausting, with victories measured in small concessions and footnotes.

Ultimately, swaps reform isn't about placing burdens on dealers through reporting mandates, centralized clearing, or saying that Bank X may no longer trade directly with Bank Y for no reason. Just as markets have evolved and continue to do so, the ways in which those markets are overseen have to keep pace. The reduction of systemic risk is the main objective-some might say the only objective-and bringing an opaque, bilateral, primarily voice-based market into the modern age is the only way to do that. It has not been a perfect ride by any means, if the amount of incorrect reporting and failures on the part of regulators to even understand the data is anything to go by.

Small problems continue to plague SEFs, as Michael O'Brien, director of global trading at Eaton Vance, states in this report's roundtable. While Eaton Vance is doing everything in line with SEF trading, he explains, it still has problems with the rulebooks that haven't been resolved, and therefore doesn't trade directly just yet. Curiously archaic rules also remain, such as the obligation to store and retain physical contracts, rather than digital copies.

But signs of acceptance are filtering through, with increased SEF volumes and data suggesting that dealer-to-client flows are increasing, even matching dealer-to-dealer numbers on the larger SEFs in recent weeks. Inevitably, the market will assert itself over time, most likely in the form of a rationalization of SEFs to a more manageable, streamlined number.

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