James Rundle: The Big Whimper

We’ve been talking about electronic execution of derivatives at such a labored pace that it appears as though it’s already been and gone. Feb. 18, though, was the first day certain instruments had to be traded through swap execution facilities (SEFs) in the US, and headline writers had a field day. Most referenced the UK’s Big Bang, the sudden deregulation of financial markets and the move from the open-outcry model on the London Stock Exchange to screen-based trading on Oct. 27, 1986, suggesting swaps were facing a similar technological transformation.

Reality wasn’t remotely as exciting. Bloomberg reports that after a week of trading on its SEF, interest-rate swap volumes simply climbed steadily. Others had similar experiences, but it’s nowhere near the power and fury of market revolution that many predicted.

This is largely because sections of the credit and rates markets have been trading electronically for a while. Even with the establishment of SEFs, many sell-side participants have been voluntarily executing on the facilities, ahead of regulatory mandates. Infrastructure and connectivity has been worked on extensively, so much so that, in the same e-mail, Bloomberg says the majority of SEF trades were submitted to clearing directly, without the use of middleware.

That’s not saying it’s perfect. The market has a long way to go in terms of technological maturity, and fully exploring the implications of areas such as SEF aggregation. But, considering the mad rush to implement systems and processes for central clearing mandates last year, this was relatively easy. Nobody really dropped the ball, and the technology, generally, worked. What has to be fully addressed, however, are archaic rules from the US Commodity Futures Trading Commission (CFTC) around requirements for storage of paper-trading agreements at SEFs, that have not only expressed confusion at this Big Bang-era requirement, but also flatly stated that they don’t have facilities big enough to do that.

Reporting
In Europe, it wasn’t quite as measured when reporting requirements from the European Market Infrastructure Regulation (EMIR) took hold on Feb. 12. Most European trade repositories said the day went smoothly, but the Depository Trust and Clearing Corp.’s (DTCC’s) facility had issues. While market participants could report on the day, the sudden influx of data meant they couldn’t see the reports, a critical piece of the puzzle for reconciliations and post-trade processes. The DTCC declined to comment.

Many were concerned about the general state of preparedness. One European trade repository, Regis_TR, apologized on its website for the length of time it had taken to onboard some customers, but reminding those who were tardy in getting their paperwork filed that it was unlikely they would be ready in time. Other critical components of the reporting infrastructure in general have also been seen as incomplete, such as issuance of universal trade identifiers and pre-legal entity identifiers. Indeed, in a thinly veiled barb directed at the buy side, many vendors and bank staff claimed that institutions that should have registered for these identifiers hadn’t bothered to do so yet, or were unaware that they had to, assuming that the sell side would just do it for them. Not so.

The overall picture is a mixed bag. The derivatives markets are finally feeling the effect of change that’s been analyzed and dissected for years now, and it seems we’re truly entering the phase where a new market structure becomes a reality. On the other hand, it’s been botched on many levels, with incomplete processes and legislation riddled with holes. For the sell side, as opposed to pure regulatory risk, there seems to be a further kind of risk evolving—that of forced compliance without the necessary tools, or developed thought behind the rules in the first place, to do so, coupled with a lackadaisical approach from buy-side clients that are more concerned with regulation that directly affects them.