SEF Market 2014 - Euromoney

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THOMSON REUTERS
OVERALL MARKET
SHARE WINNER
MULTI-DEALER
PLATFORMS
1007822.indd 1 8/18/14 9:30 AM
THE STATE OF THE SEF MARKET
DESTINATION UNKNOWN
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THOMSON REUTERS
OVERALL MARKET
SHARE WINNER
MULTI-DEALER
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1007822.indd 1 8/18/14 9:30 AM
SEF MARKET DESTINATION UNKNOWN
3
AUGUST 2014
CONTENTS
INTERVIEW: SCOTT OMALIA,
COMMISSIONER, CFTC
When Scott OMalia approved the fnal swap execution
facility (SEF) rules in August 2013, he did so reluctantly.
His fears were realized when the regime quickly wrought
international havoc. In one of his last interviews before
leaving the US Commodity Futures Trading Commission
(CFTC), he relives the ordeal of bringing these rules to
market and highlights many of the challenges still to come.
5
SEF SURVEY RESULTS: FX MARKET
SEFS STRUGGLE TO GAIN TRACTION WITH CLIENTS 16
SEF SURVEY RESULTS: IRS MARKET
INTERNATIONAL PLAYERS SLOW TO ADAPT 18
MARKET FOCUS: FROM CONFUSION TO CONSOLIDATION
Swap execution facilities were supposed to bring transparency
and price certainty for the whole market. Instead, though, they
have forced traders back onto the phones and fragmented
liquidity internationally. But whether markets like it or not, the
changes are here to stay, so how best to adapt?
9
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4
AUGUST 2014
In this report, Euromoney Research Group
sheds light on the trials and tribulations of the
introduction of swap execution facility (SEF)
rules in the US and its effects globally.
After the shock of rapid and sweeping
structural market changes, we talk to one of
the regulators instrumental in establishing them.
US regulators are now working out the kinks in
the legislation and hopes are high for continued
adoption of this way of trading.
To ascertain the remaining challenges,
we surveyed FX and IRS market participants,
including buy-side frms such as hedge funds,
banks, corporates and insurance companies
all around the world. ERG also spoke to the
majority of market-leading SEFs to get their
views on where this market is going.
Issues covered in this report include the
continuing global regulatory work, as countries
attempt to comply with the principles agreed
at the G20 Pittsburgh summit in 2009. We ask
whether enough cooperation is happening
among regulators and what can be done to
speed up the process. We uncover the barriers
to trading on SEFs and what market participants
say will encourage them to transition to this way
of doing business.
Throughout the process we found market
participants to be open and honest about
the diffculties faced and those that lie ahead.
Underneath it all, however, was a confdence
that everyone will beneft from the increased
transparency that is at the heart of introducing
SEFs.

Catherine Snowdon
Editor, Euromoney Research Group
EUROMONEY RESEARCH GROUP
THE STATE OF THE SEF MARKET
DESTINATION UNKNOWN
INTERVIEW
5
AUGUST 2014
Euromoney: Are you happy with how the
introduction of the SEF regulations has
gone so far?
OMalia: I am very optimistic about swap
execution facilities (SEFs). We were able to
create an environment that was fexible, that
would give everybody the opportunity to fnd
the best way to transact their products and
recognize the differences between the swaps
and futures markets.
There are large notional size trades, but
relatively few of them. So weve shown that
people can transact through an electronic
platform so we get the transparency that suits
the market and our regulatory purpose. Now
we are trying to fgure out the best way to really
move this forward.
In credit default swaps youve got
tremendous uptake on screen, but these are
more standard products of course. Dollar-
denominated interest rate swaps are seeing
more volume than non-dollar-denominated. Our
challenge is to bring more liquidity to the market
and more buy-side participation.
Poor buy-side participation is eminently
fxable. Any issues they have regarding SEF
access, rule-book issues, how many SEFs they
want to access, what products are being traded,
where the liquidity is in these markets - those
are the issues we want to attack.
What about broadening the range of
products available on SEFs?
We need to consider newer products, such
as packaged trades. We have more and more
of these going on-screen: lets see if that helps
increase participation.
Weve spelled out a schedule for new
products so people have some certainty. Its
important to phase these things according to
the complexity and different features of each
product.
For example, if the CFTC determines that
non-deliverable forwards (NDF) are suitable for
clearing, the next step will be to determine the
process for making them available to trade.
When it comes to NDFs, Ive heard
concerns about integration, physical connection,
transaction integration, clearing and exchange
trading intermediation and so on. This is not the
futures market. We need to understand if there
are complications around the role of prime
brokers, for example.
But as I understand it the NDF proposal is
complete from a staff level and it is ready to go
to the CFTC fairly soon.
How aware are you of the widespread
confusion in the market when it comes
to the SEF rules?
I am very sympathetic to the marketplace and
their level of confusion. We have gone through
a three-year rule-making process in which weve
done 68 fnal rules. We have rushed through
these rules at record pace. Ive never seen any
other federal agency move this many rules
this quickly. And as a result weve made some
mistakes.
Our challenges manifest themselves in the
data. Weve had well over 190 staff no-action
letters [statements overriding or changing
specifc parts of the fnal rules]. Weve issued
temporary relief, permanent relief and every
variety thereof, all trying to accommodate the
rules.
Im supportive of the no-action relief
obviously because we have to offset the rush
that we did the rules in and the complications
that weve created as a result.
My frustration is when you look at the
entire way weve gone about this. Going so
quickly we havent asked the right questions.
We didnt expect many of these outcomes and
as a result were actually backtracking through
the no-action relief to try to accommodate
technological policy changes that the market is
not ready for.
What are you doing to address the
issue?
Early on I have been consistently asking for
a schedule, what rules we are going to do
and when, so people can get their minds
around the rule order and the phase-in of the
implementation dates.
The market needs to know when they
need to have connections, relationships and
new paperwork in place to make sure they are
able to trade and clear all of these products
as expected. And report data too, which is
important.
We also need to consult the market and
ask what is possible. The schedule is a problem
and its been a consistent problem for the past
three years.
What sort of response do you get from
the market when you ask questions?
The market has had a very steep learning curve.
Early on there was a little bit of denial about the
expectation of how far we would get and how
quickly we would get there.
But everybody now completely understands
what the rule set looks like.
They are anticipating and helping us
understand how the infrastructure, the SEFs,
the clearing houses and the data reporting will
function and does function and what can be
done in what period of time. Thats very positive.
INTERVIEW:
SCOTT OMALIA,
COMMISSIONER, CFTC
When Scott OMalia approved the fnal swap execution
facility (SEF) rules in August 2013, he did so reluctantly.
His fears were realized when the regime quickly wrought
international havoc. In one of his last interviews before
leaving the US Commodity Futures Trading Commission
(CFTC), he relives the ordeal of bringing these rules to
market and highlights many of the challenges still to come.
I am very sympathetic to the
marketplace and their level of
confusion
INTERVIEW
6
AUGUST 2014
What happened to make market
consultation ineffective before the rules
were released?
People got confused by the lack of specifcity in
our questions. We werent able to pull the right
information out as a result and the industry was
left guessing what we wanted. So there has been
miscommunication and false expectations about
what these rules were going to be.
Footnote 88 had wide implications. Were
the effects intended?
This is where our cross-border rules over-
reached. We were trying to guess at some of
these things and what the ramifcations would
be. When we read the statute we knew we
were well beyond our ability to enforce it. The
statute essentially says we can apply our rules
extraterritorially to the extent it has a direct and
signifcant impact on our economy.
So you have to ask yourself, what is a direct
and signifcant impact? We never received a
satisfactory answer as to how a US person
involved in exchange trading outside the US
would bring risk to our shores, especially if the
trade is cleared.
We just applied the rules broadly and as a
result we over-reached. We hurt relationships
internationally by expecting to apply our rules in
foreign jurisdictions.
Instead we should work with colleagues
internationally to make sure we have the
comparable rules that we can all rely on.
Share the data and have the confdence that
each others clearing houses are robust and
completely in line with international standards.
Then with execution we can work out deals
to make sure we have that comparability so you
dont create an arbitrage opportunity that would
excuse people to trade somewhere else and
undermine our rules. But at the same time we
dont police the world, so we have to do this in a
cooperative fashion.
Do you remember how long you had to
read over the rules before they became
fnal?
We negotiated them for over a year. But
footnote 88 came in at the very last minute. It
was not in the draft proposal that the market
saw. It came into the fnal draft; the market didnt
see this thing coming.
Europe didnt have any reason to fear a SEF
rule that was to be applied domestically but
then all of a sudden it applied everywhere. And
you begin to understand, this is crazy. Traders
in Europe, trading and clearing there but with
either a lawyer or some expert here, and all of a
sudden its a US trade. It doesnt make sense.
There is a lot of energy spent trying to
understand and comply with the rules when,
had we made them with a more international
mindset, we could have saved everybody a lot of
time and energy.
Turning to international cooperation, is
enough discussion happening between
regulatory bodies around the world?
From the beginning weve had good relationships
and good intentions among all the regulatory
entities. There are some differences in the rule
sets and there are certainly timing differences,
which bring certain challenges.
Asia is not as keen on exchange trading and
we have some clearing and trading timetable
differences with Europe.
Data is a great test case. Everybody
fundamentally agrees on the objective and we
are all in a process of implementing swap data
repositories.
Now we have to solve the really diffcult
challenge of harmonizing the data. We need to
unify, as regulators, that form and format the data
should come in, so we can begin to share it and
do broader market analysis.
We need agreements to be able to share
the data. Because as appropriate from time to
time we will need to share information about
certain market participants. Or simply compare
notes about where there is risk build-up.
Weve made some headway. We have the
facilities in place and we have reporting. The US
has had reporting for over a year, Europe wasnt
far behind, but we need to take the next steps
and we need to do so immediately.
This is a diffcult situation to manage. Data is
complex and it requires very specifc outcomes
Scott OMalia
CFTC Commissioner
Footnote 88 says that a facility would be
required to register as a SEF if it operates in
a manner that meets the SEF defnition even
though it only executes or trades swaps that are
not subject to the trade execution mandate.

This changed everything
Brought many more products into SEF realm
Rules applied to trades with all US persons
If a US entity was involved somewhere in
the trade, the rules applied
Caused shockwaves around the world
Footnote 88:
INTERVIEW
7
AUGUST 2014
and inputs and we need to make sure that we
understand what those are so we get good-
quality data.
Right now I would characterize our data
quality as poor. There are inconsistencies coming
in in terms of how people report and we have
four different data architectures that make our
job more complex.
What about when it comes to clearing?
We have clearing houses internationally; we
know the standards and we understand what the
risk management and oversight responsibilities
look like. Weve been doing it for years. Its
important we get international recognition
sooner rather than later for one anothers
jurisdictions because weve all agreed to the
Principles for Financial Market Infrastructure.
If we dont recognize global clearing
structures we will fracture liquidity and that could
be intractable for a while, which wouldnt be
good for anybody.
Ive sent a letter to commissioner [Michel]
Barnier [European commissioner for internal
market and services] making sure we stay
focused on these issues and I know they are
supportive of these goals. But at the same time
we actually have to recognize one anothers
jurisdiction and the entities within it.
We are never going to get to a rule-by-rule
analysis. Its an outcomes-based objective; we
have to be fexible to some extent so we can
continue to recognize one anothers rules even
though they dont exactly match up.
If we try to make them exactly match up
we will not succeed. There has to be a dialogue
which is a little bit more aggressive in terms of
getting to outcomes by the end of the year to
achieve them.
Thats the set timeframe?
My understanding is that December 15 is a hard
deadline for European clearing houses to comply
[with European regulations] and the market
needs that certainty. They need to know the
schedule and which clearing houses Europeans
will be able to transact with.
They need to be able to make the decisions
and, if it comes with conditions, what they are.
And how diffcult they will be to comply within
the timeframe.
Do you get a good response when
you engage in conversations with your
regulatory counterparts around the
world?
Absolutely. The US in my opinion had a broad
overreach of our cross-border rules and that
hurt negotiations going forward. It damaged the
relationships in some respects.
We are doing a good job of healing those,.
but we have to demonstrate that by action not
just by words. The easiest and best frst step
would be on data. Lets get to a recognition on
data harmonization.
Weve taken some diffcult steps and not
necessarily successful ones on trading. We have
the most time on trading; Europes trading
mandate isnt until 2016. We now know what
their rules, by and large, look like for multilateral
trading facilities [the European equivalent of
SEFs]. Having discussions now about timing and
structural differences between the regimes will
bring about better regulatory harmony when the
trading mandate in Europe occurs.
Weve sent enough letters back and forth.
Now its time to sit down, put our lists on the
table and work out how to solve our differences.
Asia seems a long way behind in terms
of adopting similar rules. Does that
worry you?
Im not so worried about it because speaking
with the regulators throughout Asia, they are
committed to this effort. Liquidity in those
markets is less and the size of the markets is
smaller but I dont have a sense that they are any
less committed to making the necessary reforms.
Were going to have to adjust for time but I dont
sense any lower dedication to the end goals.
What about the idea of a universal rule
book for SEFs? Could that work?
No, its not possible. This is a principles-based
system of outcomes, we are never going to be
identical. Its about accepting the differences and
how you are going to solve those.
There are questions about the
consistency of data being reported
in the SEF market. Do you regret not
being prescriptive enough in the rules?
With regard to data you have to be very
specifc about what you want. We have
questioned the market about how to improve
our data rules. We need to eliminate the
inconsistencies between the various rules to
improve data quality and reporting.
We dont want a rule set where there
are various possible outcomes. To provide that
certainty will improve the quality of the data
and allow us to get what we want out of it.
We went into this asking for everything
and not knowing how we would use it or for
what purpose. Ive challenged our staff and
the CFTC to think about our priorities in data
and technology. Now that we see how big a
challenge the data is, we are not going to be
able to do everything immediately.
Whats your top priority?
I would put risk management at the top of the
list. Understanding bilateral risk management
or knowing in which asset class we are seeing
a big build-up of risk. The London Whale was
a good reminder that these things can happen.
We need to have very clear insight into whats
in the clearing house and whats outside it and
know where risk is building.
Its a very exciting opportunity; we now
have all of this data for the frst time. We are
looking at how to use it to best effect.

You are forward-thinking when it
comes to the use of technology. What is
your focus?
Data integration is key. You cant develop
the full picture without pulling all the pieces
together.
Were looking at what it means to have
complete surveillance of our markets and how
to do comparative analysis between fnancial
products. You have to always be thinking about
cross-market trades as well. Working with Finra
[the US Financial Industry Regulatory Authority]
and the SEC, we need to think about what the
next generation of data surveillance looks like.
Ive been advocating for a strategic plan
largely because we need to put on paper our
priorities based on our mission and needs. We
need to understand what we need in terms of
hardware, software and personnel expertise.
We need more data scientists people
who can work with the data effectively, who
can programme and develop automated
surveillance tools. The massive amount of data
The US in my opinion had a
broad overreach of our
cross-border rules
Right now I would
characterize our data quality
as poor
INTERVIEW
8
AUGUST 2014
that we take in is not something we can throw
people at; this has to be an automated process.
After all, you are taking on an
automated market.
Exactly. They are trading in a 21st-century way,
we are surveilling it in in my opinion a very
20th-century way. And thats just not going to
be a successful endeavour in the long term. We
need to adjust to the realities of the way the
market trades.
We need to bring in order data, something
Ive been asking for and something weve
provided absolutely zero funding for this year. In
automated trade tools, the behaviour and how
they trade is in the order data, not necessarily in
the transaction data, which is almost stale.
Expanding the types of data we collect will
be a learning experience; its not something
well be able to quickly intake. Its a massive
amount of data, physically. And then to do the
analysis, its a huge task. But we need experience
with that now, so we can be effective in the
future.
Id like to see a bottom-up approach, have
the divisions in this building tell us what they
believe their priorities should be and then the
CFTC can take all the different priorities and
knit it together for a full strategic plan. It has to
be a one-year and a fve-year vision, because
this isnt going to be done overnight. Waiting
for this strategic plan is painful and its long
overdue.
Statutorily we were required to implement
a strategic plan one year after the presidents
inauguration. Were well past that date.
Whats causing the delay?
A lack of focus on the specifcs. We havent
focused intensely enough on our priorities and
the specifc technology and mission functions
that we want to achieve. Those are hard
decisions to make but there hasnt been enough
attention paid to it and therefore we dont have
any results to show for it. I keep talking about it,
raising the pressure and the issue to hopefully
create some sort of catalyst in order to get this
done.
Do you have a technology team, with
data analysts already?
We do, but we dont have nearly enough. We
have different skill sets, some are very good with
programming, some with market surveillance, but
there is a lot more that needs to be done. It will
be dictated of course by the mission we take on.
If we are going to expand, for example, our risk
analysis, thats a different skill set we need.
Do you have enough staff with the right
market experience to oversee this
complex market?
As a result of the rule-making we have really
enhanced our market knowledge. This is a
market that was outside of our jurisdiction,
so there shouldnt have been an expectation
that we knew everything about it. But it is now
completely within our jurisdiction and we are
building a lot of knowledge and experience.
Our learning curve has been steep but
we have tackled it very well. I am impressed
with the enormous amount of hard work,
time and energy that has gone into this. The
staff have learned fast and tried to write rules
that accommodate the nuances and unique
characteristics of the swaps market.
By and large we got them right, but
we made some errors. Now we are in the
implementation-correction phase. If we stopped
doing the corrections and said we got it right
thats when wed have problems. We are willing
to consider changes and that is healthy and
appropriate.
What about start-up SEFs struggling
with poor volumes and slow uptake?
Do you expect to see consolidation?
I appreciate that the willingness to invest in
these and try new technologies and innovations
takes great commercial spirit. And I know that
of the 20-plus SEFs that have come in for
registration not all will survive.
But I like the different ideas that people
are coming up with and the different products
coming out. Innovation is going to be a great
thing for this market and it will create new
opportunities.
I cant predict where this will end up, but
we are looking at ways to get more trading
done on-SEF and allowing people to transact in
the way they want to.
SEFs are going to continue to evolve and
I dont want us to insist on a single solution;
we need to learn from the equities market in
terms of fragmentation and what can happen
there. This is a new market and we need to
stay fexible and think innovatively, just like the
market participants are.
What has been the biggest challenge in
your term?
Its diffcult when you are presented with what
is deemed a consensus document led by the
chairman and supported by the staff and told:
Here it is, take it or leave it.
The hard work has been to try to forecast
what could and might go wrong and to do my
own independent research and analysis into
how the market might not function as well as
expected under this rule.
That requires a lot more work on our side.
My staff have had to work very hard to think
critically and anticipate something other than
what is being sold to us.
Are you likely to seek another term?
[With a wry smile] I do love this job. Ive had
a lot of experience on Capitol Hill, developing
rules and statutes and I thought that was a
terrifc job. But to have the opportunity to
be on the receiving end of the statute and
be asked to get the details right is different.
And the details clearly matter, so to take it
to the next level in terms of policy analysis is
fascinating to me. Ive enjoyed all of my policy
jobs here in Washington but this one is special.
The stakes are very high and the outcomes are
important.
[Since talking to Euromoney, OMalia has formally
resigned from his post at the CFTC. He will
take up the position of chief executive of the
International Swaps and Derivatives Association on
August 18.]
This article was frst published on August 8
I know that of the 20-plus
SEFs that have come in for
registration not all
will survive
We need to bring in order data, something Ive been
asking for and something weve provided absolutely zero
funding for this year
MARKET FOCUS
9
AUGUST 2014
The introduction of the US swap execution
facility (SEF) rules has caused problems, globally.
Markets have battled to adjust to this new way
of trading and the fght, for many, is not over.
The concept underlying the rules was
straightforward: at their September 2009 summit
in Pittsburgh, G20 leaders agreed that by the end
of 2012 at the latest, all standardized over-the-
counter (OTC) derivatives should be traded on
exchanges or electronic trading platforms where
appropriate. The International Organization of
Securities Commissions (IOSCO) was involved
from the start, setting out detailed principles for
securities regulation. Although no G20 member
met the 2012 deadline, the US has taken
substantial steps towards full implementation.
On July 21 2010, president Barack Obama
signed the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act). The
legislation tasked the US Commodity Futures
Trading Commission (CFTC) with overseeing a
large part of the US swaps market.
The fnal rules were ready by August 2013
and set out their goals:
Title VII of the Dodd-Frank Act amended
the CEA [the Commodity Exchange Act,
which lays out the statutory framework under
which the CFTC operates] to establish a
comprehensive new regulatory framework for
swaps and security-based swaps. A key goal of
the Dodd-Frank Act is to bring greater pre-trade
and post-trade transparency to the swaps
market Such transparency lowers costs for
investors, consumers, and businesses; lowers the
risks of the swaps market to the economy; and
enhances market integrity to protect market
participants and the public.
A level playing feld for market participants
with better transparency and lower risk prompts
no complaints. The rules and guidance that came
with them defned the type of trading platforms
required to register as SEFs, the core principles
by which they must operate and the execution
methods to be used. Simple? Or not?
When research on this market is undertaken,
the word most commonly used by market
participants to describe the rules is confusing.
The task of deciding how and when to phase in
these regulations and who would decide which
asset classes and instruments they would apply
to must have been daunting. As outgoing CFTC
commissioner Scott OMalia acknowledges,
mistakes were made along the way. But those
closest to the market understand the diffculties
involved and accept that the US moved quickly
in an attempt to give markets certainty as soon
as possible.
The EU is following a principles-based
approach and is taking longer to come up with
the regulations, says Paul Millward, product
manager FX at GFI Group (a SEF). In the US
the rules were fnalized much more quickly. They
are clear and well defned although of course
there are still issues that need to be worked
through.
Scott Fitzpatrick, chief executive of Tradition
SEF, says: The CFTC came out of the gates
very quickly, and were very aggressive with their
timelines for implementation. To an extent I
respect that they went frst, someone had to. But
I dont think they spoke to enough people for
long enough before they issued these rules.
Some observers try to look for the positive
aspects of the US racing ahead in introducing
regulation.
In coming out with their rules so fast,
the US is giving us empirical evidence of how
markets and liquidity are affected by this type of
regulation, says Peter Best, chief operating offcer
at Icap SEF.
Unintended consequences
Even the most pragmatic of market participants
were shocked by the way the rules were blasted
out however. Last-minute changes had large,
possibly unintended, consequences. The most
prominent example of this is footnote 88.
The footnote says that a facility would be
required to register as a SEF if it operates in
a manner that meets the SEF defnition even
though it only executes or trades swaps that are
not subject to the trade execution mandate.
This changed everything. Before this point,
products would only have been required to
trade on a SEF if they were subject to the
mandate, which was only applicable to products
that were required to clear. Add in that the rules
applied to trades with all US persons. This
meant that whether or not the person actually
doing the trade was a US citizen, if a US entity
was involved somewhere in the trade, the rules
applied. This generated shockwaves around the
world in the complex global markets.
Market participants describe being
fabbergasted and stunned when they read
the footnote.
Prior to SEF rules being published, people
expected the rules to be applied incrementally,
says Best. Footnote 88 threw people off. It came
as a shock to the industry and the logistics of
delivering on these rules proved challenging.
Fitzpatrick of Tradition SEF adds: That
footnote took this from being a relatively logical,
narrow-scoped set of products that were
going to be subject to mandatory clearing and
everyone knew would ultimately be subject to
mandatory trading, primarily in the US between
FROM CONFUSION
TO CONSOLIDATION
Swap execution facilities were supposed to bring
transparency and price certainty for the whole market.
Instead, though, they have forced traders back onto
the phones and fragmented liquidity internationally. But
whether markets like it or not, the changes are here to
stay, so how best to adapt? Euromoney Research Group
investigates.
I believe well see a fight to
quality, only the strongest SEFs will
make it

Zohar Hod, SuperDerivatives
MARKET FOCUS
10
AUGUST 2014
US participants, to instead affecting your entire
global swaps business. It was incomprehensible.
From being a US issue, this became a global
implementation of CFTC rules. It was a
completely unmanageable situation given the
timelines that were being set out. There was
certainly a moment in time where we were
dealing with global chaos.
George Harrington, global head of fxed
income, currency and commodity at Bloomberg,
says that although the situation is now improving,
footnote 88 did not help proceedings. The lack
of clarity in the rule-making process has caused
a level of uncertainty in the market, he says.
Cross-border guidance has sometimes been
conficted and, as a result, many participants
chose alternative execution methods to SEF
trading.
For the FX market, the shift caused by
footnote 88 was particularly shocking as it meant
market participants were drawn into the fray
long before they expected to be.
In terms of impact on the FX market it
has meant lots of work for the venues, to be
assessed to comply with and meet the SEF
registration requirements, says Best. Platforms
with an FX bias werent prepared for this.
The footnote also had implications for the
buy side.
Non-deliverable forwards [NDFs FX
instruments traded on SEFs] were slowly
becoming increasingly electronic before these
rules, says Michael OBrien, director of global
trading at Eaton Vance. Now, he adds, his frm
is back to trading FX on the phone in order to
side-step the SEF rules.
The slow adoption of trading on SEFs by
the buy side is a worry for SEFs, particularly
the start-ups that need clients to make their
investments worthwhile. For some, the negative
reaction was expected.
I think the buy-side response generally to
this regulation, and to all regulation that Ive ever
seen in my career, is: This doesnt help me, its
complicated and I didnt ask for this. And that
is what we are seeing., says Jodi Burns, head
of regulation for marketplaces at Thomson
Reuters. I dont think it should have been a
surprise to anyone. I think you have to take
a long view when it comes to assessing the
benefts of regulation.
For OBrien the delayed uptake is more
than justifed. Were talking about a giant, rapidly
changing market structure, he says. I know
people have put money into SEFs and various
different business models that rely on the buy
side coming to the SEFs, but my concern is our
funds shareholders, not whether someones
business model is justifed or not.
Complex on-boarding
There are a few reasons for the slow uptake of
on-SEF trading. A big one is the arduous process
of on-boarding with each platform. Clients must
agree to sign up to a rule book, which is different
for each SEF they want to trade on, and can run
into the tens or even hundreds of pages.
From an asset-manager perspective we
have to think about how this fts into our internal
agreements and relationships with clients, says
OBrien. Can we sign up a client for this? One
of the fears in the beginning, and no one talks
about it anymore although Im not sure its
been addressed, is if I trade on a SEF for a client
account, does that mean the SEF can go and
audit the clients books? Once you start to think
through some of these things, its insane. SEFs will
say they dont plan to do that, that they have to
have that language in the rule book by regulation,
but that doesnt mean I want to take that risk. I
know a lot of buy-side frms have signed up for
these rule books, I dont know why.
The process of on-boarding is also a big
undertaking for the SEFs. Bloomberg has taken
a client-by-client approach.
We work with a wide spectrum of clients
that represent a number of different geographies
and sizes, says Bloombergs Harrington. Our SEF
has more than 800 global participants and more
than $5 trillion has been executed (across credit,
rates, FX and commodity derivatives) since our
October launch. Each of these clients has specifc
needs, but our general approach is to understand
these needs and how they can beneft from our
SEF technology and experience.
Once a client has signed up it must be
aware that it is transacting in a constantly shifting
landscape.
Rule books across the SEF community are
changing monthly for all sorts of good reasons,
like expiry of CFTC no-action relief letters
and so on, says Fitzpatrick. No-action relief
letters have been issued by the CFTC to relieve
market participants from parts of the rules
while regulatory kinks are sorted out. They are
effectively temporary or sometimes permanent
rule changes and all 190-plus of them must be
refected in the SEFs rule books.
SEFs have to update their rule books as the
CFTC provides further guidance on the rules,
says Grigorios Reppas, CDS product manager
at MarketAxess. In the beginning we were
updating every week, now its about once every
two months or so. But that could change again.
Burns of Thomson Reuters, thinks a process
of adjustment is needed. The buy side is less
used to being regulated; they dont all have a
compliance offcer and an army of lawyers to
help them fgure out what the rules of conduct
are, she says. The idea that they have to agree
to abide by a rule book is a foreign concept to
them. There is seemingly no upside to joining
SEFs directly. It opens them up to compliance
obligations they would rather not deal with; they
just want to trade.
Failure to convert
The objection to the strict compliance
regulations also extends to platforms that had
considered becoming SEFs. One international FX
trading platform that ultimately decided not to
make the move to become a SEF had estimated
the costs of doing so as in the millions of dollars.
Wed need a new compliance and technology
team dedicated to this facility, separate from the
teams we already have in place for the rest of
the business, the head of the European arm of
the platform tells Euromoney. It didnt make
business sense for us, he adds.
At a CFTC event in June, Wendy Yun, a
managing director at Goldman Sachs Asset
Management, stressed the importance of the
I know a lot of buy-side frms
have signed up for these rulebooks,
I dont know why

Michael OBrien, Eaton Vance
MARKET FOCUS
11
AUGUST 2014
over-arching impact of these regulations on the
market. She said the costs relating to trading
on SEFs, including when it comes to assessing
rule books and developing technology, were big
concerns.
At the same event, Lee Olesky, CEO and
co-founder of Tradeweb, admitted that the
integration process for each client was massive.
Burns at Thomson Reuters remains upbeat
about the situation. Uptake has been what I
expected, she says. Given that no one was
required to trade [FX] on SEFs the fact that
any SEFs have customers is a good thing. The
Thomson Reuters SEF has over 200 buy-side
customers prior to the mandate. Were pleased
with that uptake, as well as our market share
and the number of liquidity providers who have
joined the SEF.
Were also pleased with the fact that some
of our buy-side clients have joined the SEF
despite the fact they arent subject to Dodd-
Frank. They want to trade with counterparties
who are [on the SEF], in order to continue to tap
into all the liquidity pools that they had before
there were SEFs. So theyve joined the SEF
voluntarily. To me thats the biggest endorsement
of SEFs and our platform.
Bloomberg is also content with business.
Weve been pleased with the level of
participation and volumes executed on our SEF,
says Harrington.
Referring directly to the Thomson Reuters
SEF, FXall, OBrien explains why for him, the
option to trade on a SEF is closed for now.
Because of footnote 88 and rule books being
what they are I cant trade FX on the SEFs, he
says. FXall is a good example, I cant use them
because of the SEF rule, even though NDFs
dont have a mandate, I cant use them. Were
back to trading on the phone.
Asked if this back-tracking is problematic,
OBrien is nonchalant. Electronic is a more
convenient way to get competing quotes, but its
not a big deal for us to be back on the phone,
he says.
Trading off-SEF
For those choosing not to trade on SEFs there
are alternatives. One popular way for customers
to access SEF liquidity pools without on-boarding
with a SEF is to use an introducing broker, which
is a term set out by the SEF rules.
A frm can become an independent
software vendor, which means SEFs allow
impartial access to their markets. However, once
the code is designed and connected to the SEF,
the provider is merely a front end for the data.
To get to the next step and allow clients to trade
electronically on the SEF, they must become an
introducing broker. UBS has done that via a
SEF aggregator on its NEO platform.
Building the SEF aggregator was part of
our response to help clients continue trading
certain swaps post the Dodd-Frank legislation,
says Mark Russell, head of EMEA FRC execution
services. The main idea was to aggregate all of
the SEF central limit order books into a single
screen so our clients didnt have to worry about
choosing the right connection points to access
the best liquidity. With our aggregator they have
access to multiple SEFs in one place.
There is increasing pressure on other
banks to come up with similar offerings, and
rumours are rife of joint ventures between hi-
tech trading platforms and banks. Credit Suisse
appears to have gone furthest in developing
a SEF aggregator, with reports saying the bank
will launch the facility in August 2014, although
confrmation was not received from the bank at
the time of going to press. Russell says he isnt
worried about competitors: We know others
are building similar products, but competition is
good. In some ways it justifes your decision to
be the frst mover.
OBrien uses the UBS aggregator and would
like to see more options. UBS is the only model
right now that gets us where we want to be,
he says. At this point it does surprise me that it
is the only one. Given all the problems with the
rule books and the complexity of the buy side
getting onto the SEF, I would think more people
would be doing it and I suspect they are, they
just havent come to market yet.
UBS is seeing uptake globally, but there is
less demand outside the US in countries where
traditional trading methods are still acceptable,
beyond the reach of the Dodd-Frank Act. As the
direct participant, UBS must sign the SEFs rule
book, something Russell is relaxed about.
We are taking on this responsibility; it is part
of the service to our clients, he says. There are
some rules that apply to everybody, regardless
of whether you are a participant or accessing as
a client of our introducing broker service, and
then there are some which apply only to the
participants.
Despite the bank signing the rule book, this
does not mean clients that access the market
this way are beyond the rules reach. Customers
of SEFs are all subject to the rules in some way,
you cant trade through an exchange or a SEF
and not be subject to the jurisdiction of the SEF
and therefore the rules, says Fitzpatrick. The
onus of responsibility for the understanding and
applicability of the rules sits ultimately with the
entity transacting on the SEF.
Reppas agrees: At the end of the day,
everyone is under the jurisdiction of these rules.
You can fnd alternative ways to access the SEF
without needing to sign up directly, such as using
an introducing broker, but the rules still apply.
Innovation is never lacking in the lucrative
fnancial markets and there are other platforms
that will allow easier access to SEF markets on
the way. SuperDerivatives, a trading technology
and analytics frm, has created SDeX, which is
described as a trade communication system. It
enables participants to price bespoke products
across asset classes, none of which is currently
mandated to be traded or centrally cleared. The
frm has applied to register as a SEF to be certain
it complies with US rules, but is determined not
to call its platform a SEF.
For SEFs, the different models and the
competition they generate is troublesome.
I am happy to compete with other SEFs for
their business; its competing with the alternatives
to SEFs that is hard, says Burns. Its not a fair
Check for unique offerings
Do they cover the asset classes you want to trade?
Liquidity is crucial
Trading protocols do they align with yours?
Read the rule book carefully
Question if you need to join any alternatives available?
Dont panic and on-board too quickly, its an expensive and time-consuming process
(Summary of advice from SEFs spoken to by Euromoney)
Advice for newcomers to SEFs
STUDY THE SEFs
MARKET FOCUS
12
AUGUST 2014
playing feld because those non-SEFs dont have
regulatory requirements, so Im competing with
an arm behind my back.
Yet Burns understands why some potential
clients might be reluctant to join a SEF when
it comes to the FX market in any case. Some
global corporations are trading FX because they
dont have a choice, she says. They have global
payroll obligations; they are collecting revenue
where they are not headquartered and therefore
need to repatriate that revenue back to their
home currency. Its just the cost of being in the
business they are in. So they dont understand
why they have to go through all these hoops just
to continue trading.
However, the day is likely to come when
they will have to. Trading mandates are expected
to follow. Unfortunately the road from this point
in the phasing in of SEF rules is far from clear.
Timings for new rules are still uncertain and as
the CFTCs OMalia admits, there is much work
to be done to correct mistakes in the rules
already implemented.
International wrangling
One hurdle to overcome is the apparent lack
of cooperation with regulators around the
world. A big concern for the market participants
Euromoney spoke to concerned the clearing
mandate for swaps, and how timing and
coordination on this front would work.
The CFTC has indicated it might introduce
mandatory clearing rules by the end of this year,
says Best. So now we are beginning to think
about how we will accommodate execution-
level requirements in a very real way. We have an
electronic NDF platform, but we need to focus
on how we get permission for access across
other regulatory jurisdictions.
Burns says of the clearing mandate: This
is still a work in progress. There are some very
basic operational issues that have yet to be made
crystal clear, which is an additional challenge for
everyone who is involved in the clearing process.
It is hard to build systems because you dont
really know what your requirements are.
It is expected that in Europe the earliest
that mandatory clearing will begin is the end
of this year, and at the latest next summer. The
deadlines are dependent on the European
Market Infrastructure Regulation, under which
clearing and the authorization of clearing houses
are regulated.
Reppas thinks participants might already be
testing their processes on SEFs. We are now
seeing a trend of European investors trading
increasingly on the SEF, he says. The reason is
that more and more clients are starting to clear
their index positions. Here in Europe we will
have the clearing mandate very soon, so these
clients are preparing for that and the perfect
venue for them to try these things is on the SEF.
Unfortunately there is no sign of a real
effort to ensure that the US and European rules
work in harmony to allow effcient clearing of
international trades.
Coordination between international
regulators has been at times diffcult. An example
is the apparent collapse of the negotiations
between the US and Europe over qualifed
multilateral trading facilities (MTFs), an agreement
that could have allowed swaps traded on the
European equivalent of SEFs to avoid much of
the pain of the Dodd-Frank Act. Nevertheless
the commitment to providing rules that can
co-exist without market disruption does seem
to be there.
Mifd II [European fnancial market
regulations] will deliver the G20 mandate to
increase trading of standardized derivatives on
transparent venues, says David Bailey, the UKs
Financial Conduct Authoritys head of market
infrastructure and policy. Esma [the European
Securities and Markets Authority] is currently
seeking the markets input on the detailed
transparency rules and liquidity criteria that will
support this new framework across Europe.
Key to the success of the new European rules
will be the way that they interact with other
regimes. The Mifd approach is fully consistent
with international principles agreed by IOSCO
in 2011, and I welcome continued close
cooperation between regulators of the major
markets.
In the meantime, market participants are
carefully monitoring regulatory progress around
the world and trying not to worry.
For the buy side, with exposure in Europe
and the US, the lack of alignment between
the MTF rule and the SEF rule is defnitely a
problem, says Zohar Hod of SuperDerivatives.
Luckily Im a software provider so it doesnt
bother me at all.
Reppas says: It is a concern that
international regulators seem not to be working
well together.
Best says: Ultimately the new regulations
[globally] have their origins in the same place.
And therefore we are pretty optimistic that
we can make the rules reconcile and continue
to achieve a global liquidity pool. Thats not to
say that we arent tracking developments very
carefully.
Fitzpatrick believes IOSCO could have been
more infuential in the process of developing
these rules. IOSCO should have taken a more
aggressive management role in the global
structure and cooperative implementation of all
of this, he says.
No answers
And its not just conversations between
regulators that seem to be going awry. Market
participants report frustrations when asking for
clarifcations on the rules in the US. One senior
platform representative who did not want to
be identifed said the temptation was there to
simply wait for the frst round of enforcement
actions to give some clarity on the complex
rules.
But others report better experiences when
talking through rule problems with those who
created them. In talking to the CFTC I am
always pleasantly surprised by just how open
they are to discussion, says OBrien. They are
making a real effort to understand the concerns
of the market. Of course, it doesnt always mean
that they will agree.
Others acknowledge the size of the
challenge rule-makers face. I think the reason
that people cant get answers to questions is
because the people they are asking genuinely
We will assess market
conditions and work closely
with our customers to ensure our
offering meets their needs
George Harrington, Bloomberg
MARKET FOCUS
13
AUGUST 2014
dont know the answers and are still fguring it
out, says Burns.
Weve asked for guidance on certain things
from the CFTC, says Reppas. I realize that over
the last year they have been swamped; theyve
had a lot to do. They have done their best to
respond to our questions but they have been
under-staffed.
For Icap, direct conversations with
international regulators are going well. Earlier this
year the frm launched Icap Global Derivatives
Limited (IGDL), which is both a SEF and an
MTF, meaning it is currently already regulated by
both the CFTC and the UKs Financial Conduct
Authority (FCA). But thats not the end of the
process. We are seeking permission to operate
in Asia and Latin America, which will take time,
as it does everywhere, says Best. We have to
approach the authorities and seek licences to
operate. It is diffcult to know how long it will
take to get approval. Wed like to be global as
soon as possible.
Data diffculties
One of the hottest topics to address, as the
SEF rules are adjusted and platforms look to
go global, relates to the collection of data. The
CFTC is open about the fact that it is currently
not receiving adequate data about trades on
SEFs. In the Euromoney poll most respondents
said they did trust the data being gathered. But
market participants, not to mention the CFTC
themselves, know more needs to be done.
The CFTC needs to issue some guidance to
clarify what was intended for the data reporting,
says Burns. Thats the purpose of guidance.
Reppas adds: There are many different
places you can report to under the rules. The
rules were not prescriptive enough and now
direct comparisons cannot be made. Thats
something we are faced with when we are trying
to see what our market share is. Were going
through all the websites and trying to convert
data so we can see how our products are doing.
He says that the market has rectifed the
problem itself to an extent, with some informal
conventions having been established to offer
more unifed data.
But when it comes to the physical rules,
crucial points such as the currency in which
to report notional volume for FX trades, for
example, are not specifed. And when it comes
to making comparisons between SEF and
international SEF-type platforms, forget it.
Consolidation soon
With the market slow to take off, talk of mergers
and acquisitions has begun. There has been
turnover at the top of some SEFs and others
that submitted registration papers to the CFTC
appear not to be actively trading. They have
perhaps decided the market wasnt worthy of
further investment, or possibly failed to attract
clients.
Customers are sticking with names they
know when it comes to choosing a SEF, says
Fitzpatrick. When there is that much risk in the
marketplace you dont increase it by going to a
venue that didnt exist six months ago. Start-up
SEFs have the mother of all uphill battles.
Burns agrees that the newcomers have an
incredibly challenging task. Thomson Reuters
is successful because we already had a liquid
platform and we just had to layer the SEF like
an outer shell. We didnt have to compete for
new liquidity, she says. We had an existing
customer base, and we simply had to convince
them to continue using our platform with its new
regulatory outer shell.
A brand new SEF has to not only develop
surveillance capabilities and technology that
is robust enough to pass CFTC investigations
but also has to convince customers to take a
regulatory requirement that nobody wants. Thats
a very tough sell.
Reppas says: Were already seeing some
of the start-ups facing some diffculties, the data
speaks volumes. We wouldnt be surprised to see
some consolidation among SEFs in the coming
months.
Hod says: I think there is going to be more
and more adaptation [to trading on SEFs] but its
going to be very, very slow and its going to be
survival of the fttest. I believe well see a fight to
quality, only the strongest SEFs will make it.
Most of those Euromoney spoke to say they
expect consolidation, Icaps Best predicts that the
market might ultimately shrink to just four SEFs.
He says: SEFs have been going since October
last year; for both customers and SEFs there are
cost pressures relating to on-boarding and doing
business. There are also considerable additional
costs to run a platform as a SEF. I think people
are beginning to evaluate whether its worth
being a SEF anymore. Some will get consumed
by others, others will disappear altogether.
Fitzpatrick says: SEF rules will concentrate
liquidity, which isnt bad so long as you dont
concentrate it too far. Youll see very little liquidity
moving downstream; it will be moving up to the
The most important thing is to get the clearing part sorted, says Reppas. Most people who are
thinking about joining a SEF probably arent currently clearing their products; theyre doing bilateral
trades. They need to do all the relevant due diligence and get familiar with clearing.
Hod adds: One of the major effects of this legislation is that clearing is no longer an afterthought. The
trader has to think about where he is going to clear before he starts to trade.
Advice for newcomers to SEFs
CLEARING
We are beginning to think
about how we will accommodate
execution level requirements

Peter Best, Icap SEF
MARKET FOCUS
14
AUGUST 2014
incumbents, and between them as well. But as
long as you allow fexibility and competition in
an environment that breeds innovation, the rest
takes care of itself.
You might think all the talk of consolidation
would worry UBS and its aggregator model. Not
so according to Russell. Even if we envisage a
marketplace with only one SEF for each product
FX, IRS and CDS, clients would still come into
NEO and be connected to all three through a
single platform, he says. We think there is a lot
of uncertainty around consolidation, winners,
and ultimate sources of liquidity, and the timing
of change. Whatever happens, we feel we have a
solution that will continue to provide benefts to
our clients.
Even the process of joining a SEF could
become a reason for consolidation according
to Best. SEFs will need to be more demanding
with membership, documentation, and member
investigation and surveillance, he says. As these
become more routine, I think members will start
to think about on-boarding with fewer SEFs in
order to avoid the general hassle of audits and
compliance to multiple entities.
With fewer customers, some SEFs might be
forced to close.
Fractured liquidity
Competition is increased further by the
diffculties involved in the split between US and
non-US participants, which has caused a severing
of liquidity between trades taking place in the US
and elsewhere.
The dealer community now is structuring
their business into a US-persons business versus
a non US-persons business, says Reppas.
This, Best says, was the reason for
establishing IGDL. IGDL is dubbed the global
SEF, its purpose is to reconcile the SEF rules
with local regulation around the world and piece
together the fragmented liquidity. He believes
others will follow in Icaps footsteps: We would
expect to see competitors following our lead. It
is a solution to fragmented liquidity.
For now the split is creating an interesting
situation on trading foors. Weve seen split
liquidity by which most of the world is trading
off-SEF in FX until the US hours when a lot of
US dealers open up their dealing books and we
see more SEF participation, says Best. It is still
interdealer focused at the moment.
Reppas agrees. You can see that shift, he
says. We have a very good presence on our SEF
in the US. So in the morning in Europe, there
is much less SEF trading activity. SEF operations
start at 3am US time, but trading simply doesnt
happen then. It doesnt cause us any problems
because we have a complete team in London
and the US that can support SEF trading when
its active.
Developing the rules
The future expansion of SEF rules worries
everyone involved, but it was FX market
participants that were most vocal in their
consternation. Although admittedly the FX
market has had the luxury of watching how the
other asset classes have adapted to the world
of SEFs, there are still questions about how and
when the types of FX instruments to be traded
on SEFs might be expanded.
When the frst rules were proposed there
were questions about why NDFs and options
were chosen to be traded on SEFs. They are the
most complicated of FX instruments, and the
smallest part of the electronic FX market.
My personal view is that the regulators
picked them because those products were
guinea pigs, says Burns. You dont want to mess
up the forwards market. So NDFs and options
impact a smaller percentage of the FX market
space, while the regulators get it right. After that
I believe the CFTC will welcome expanding the
SEF scope to cover other instruments, but only
once they are comfortable theyve got it right.
OBrien says: I dont think NDFs are ready
for a trading mandate. There are too many
complications for SEFs and I dont think there
are enough alternatives. Until you fgure out the
problems with the rules in place, why would you
add new asset classes? You dont have to solve all
the issues, but the big ones at least need to be
tackled before we jump into NDFs.
Burns echoes the hope that any expansion
wont be rushed. I think the regulators are going
to be very ginger in light of how they expand the
trading mandate, she says. This is a multi-year
initiative. It could be fve to seven years before
we have additional FX instruments [beyond
NDFs and FX options] trading on-SEFs. I dont
think many of the start-up SEFs will have enough
cash to make it to that point.
Bloombergs Harrington wouldnt be drawn
into guessing what might come next, vowing to
be prepared for anything. Bloomberg has been
in continual contact with relevant authorities
regarding the evolving market and what we
believe makes the most sense in terms of
trading mandates, he says. We see a key part
of our mandate is to prepare clients for future
regulatory requirements and deadlines. We will
assess market conditions and work closely with
our customers to ensure our offering meets
their needs.
Educating the masses
Whatever is coming for SEF rules, one thing all
the SEFs Euromoney spoke with agreed on was
that the education of clients is paramount. They
have to understand why we are asking them to
sign up to these rules, says the CEO of one SEF.
We were holding weekly meetings in the
beginning to educate our salesforce and as a
result our end clients, says Reppas. Weve
also held client seminars to help everyone
understand the rules. Its been an interesting
process.
Harrington says: By the time our SEF began
trading last October, Bloomberg had spent years
educating clients and industry participations, and
working with regulators, regarding the transition
from over-the-counter to SEF trading in swaps
and derivatives. We held one-on-one client
sessions and large-format events, and published
white papers and other content to keep our
clients informed about the coming changes.
Burns says: Thomson Reuters approach to
regulation is: given that customers face new legal
and operational pain resulting from regulations,
how can we try to absorb as much of that pain
as possible to remove it as being a blocker to
doing business with us. I think thats why we are
There was certainly a moment
in time where we were dealing
with global chaos

Scott Fitzpatrick, Tradition SEF
MARKET FOCUS
15
AUGUST 2014
successful.
Reppas notes that the buy side is learning
by doing, with the hedge fund community
leading the way as active clients and more
traditional asset management frms still trying
to adjust their processes. On quieter trading
days you see buyside frms experimenting, he
says. We regularly see clients trading through
our anonymous protocols. Many of which, after
the transaction is done, will question us for the
counterparty of the trade. They simply cannot
comprehend that they could trade anonymously
with someone else. Its a learning process, were
getting there.
Talk to me
Its not just better communication with clients
that needs to take place. SEFs and the buy side
alike want to see a coordinated effort to talk to
the CFTC about their concerns over these rules
and the scale of the changes taking place.
This is a radical shift to market structure
and these things cant be done successfully
overnight, says OBrien. The buy side needs
to be more vocal about what they think. There
are fewer banks; they can organize themselves
more easily. For the buy side you have big frms
like BlackRock, Fidelity and Vanguard, you have
nimble hedge funds, middle-sized funds and so
on. There are some trade groups representing
parts of the market, but the buy side generally is
not well organized. I dont know if by the end of
the consultation process the same message was
getting through from the buy side to the CFTC.
Burns says: We think there should be an
industry conversation about how data should be
reported. We all have a vested interest in having
apples-to-apples comparisons made; we all want
to be judged on market share. So lets have a
conversation to agree on that.
Many other SEFs were keen for this to
happen, including MarketAxess, Icap and Tradition.
We would be interested in being involved
in an industry discussion about how data should
be reported. says Fitzpatrick. But I dont think
the SEFs should be the ones to decide what is
reported. How and the uniformity of it we can
help with.
However, there are problems facing this,
as Burns notes: [Unfortunately] Theres no
mechanism for having that conversation. If I were
to call the other SEFs to talk about this, it would
be seen as collusion.
Despite all the troubles getting to this stage
of the process of introducing SEFs, and the
undoubtedly bumpy road ahead, there are signs
things are improving. Trading data is starting to
pick up and interest from around the world is
growing as market participants accept that these
rules are here to stay.
These rules arent going away and they are
going to change day-to-day business whether
you like it or not, says Burns. Just get on with
it. You can rile at how silly this or that is, but it
wont change anything. You need to fgure out a
way to minimize pain, serve clients better, and
fnd the upside to regulation, because it is not
going away.
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Tim Moxon, Publisher, Euromoney Research Group
T: +44 207 779 8694 E: tmoxon@euromoney.com
Catherine Snowdon, Editor, Euromoney Research Group
T: +44 207 779 8288 E: catherine.snowdon@euromoney.com
16
AUGUST 2014
Trading on SEFs in the FX market has
understandably got off to a slow start. After all,
not many instruments are available for trade
this way. The concept was simple: under the
Dodd-Frank Act, in order to promote market
transparency, certain over-the-counter derivatives
products must be traded on a SEF and cleared
through a central counterparty. In the FX market,
the instruments frst brought into this regime
were options and non-deliverable forwards
(NDFs); others are expected to follow.
However, many market participants are
choosing to trade off-SEF. This was clearly shown
in the data gathered for this report. Less than
a third of those who took the survey said they
were trading FX on a SEF.
The CFTC envisaged a market where
competition was high and participants had a
choice of platforms and access to the very
best prices as a result. Our research has not
found this. Just one respondent is trading on
fve or more SEFs. The majority prefer to
choose just one platform to partner with. Our
impression is that most market participants at
this stage seem to be testing the market; more
likely not willing to go through the hassle and
expense of on-boarding with any others after
going through the process once.
Data available from the Futures Industry
Association and other publicly available sources
point to a handful of SEFs dominating in the FX
market. This was very much supported by the
responses to the Euromoney survey, which show
that Bloomberg, FXall, Tradition and GFI Group
topped the poll.
It is fairly clear from our research that
there will be a slow increase in the volume
of FX trades, but this is not likely until more
instruments are made available to trade. When
asked how market participants expect their
volume of FX trades completed via SEFs to
change, on the whole the responses pointed
to increasing volumes, but slowly over the next
year, with a bigger jump in the coming fve years.
It is possible the market is following the widely
held expectation that more FX instruments will
become available for trade on SEFs, or that a
strict mandate will be introduced during that
period.
Slow market adoption to continue
Participants choosing to trade on one SEF only undermining hopes for a market brimming with
competition
Volumes are expected to increase less over the next one to two years; increases seen as likely to
accelerate over the coming two to fve years
SEF survey results: FX
Key points
SEFS STRUGGLE TO GAIN TRACTION WITH CLIENTS
Now One year Five years 10 years
Percentage of FX volume traded on SEF
0
10
20
30
40
50
%
Expected percentage of FX volume traded on SEFs
Source: Euromoney Research Group
17
AUGUST 2014
Market participants respond to
introduction of SEF rules
One of the biggest initial fears for everyone
involved in this market, not least the CFTC,
was that implementing SEF rules would have
a detrimental impact on business fows. Our
research suggests that has not been the case,
which will be a big relief to US regulators. Start-
up SEFs may be grumbling about slow buy side
uptake and struggling business plans as a result,
but those trading via SEFs seem unfazed. The
majority say the rules have not affected business
at all; others imply a positive effect. The most
negative responses were a handful of votes
for the rules having had a mixed impact on
business.
Respondents displayed varying levels of
confusion over the SEF rules. While SEFs and
those implementing the rules directly seem to
have had more trouble, clients of SEFs seem
blissfully unaware, with most claiming to be only
either slightly confused or not confused at all.
Interestingly, the bulk of the responses to a
question about whether internationally accepted
rules might be possible indicated that they would
be. We are not sure regulators around the world
would agree. Cooperation has been painful and
talks have achieved little. Letters are publicly
being sent back and forth, particularly between
the US and European authorities responsible for
market oversight, but so far to no avail.
Data collection is still causing a problem for
the CFTC. The rules were woefully inadequate
in stating what information it wanted to gather
and how. The result has been that the regulators
currently have no meaningful data stream
coming in from SEFs and no way of making
useful comparisons between them. Additional
guidance on how SEFs must report is widely
expected in the future, but the majority of those
answering the Euromoney survey said they
thought the numbers being distributed by the
SEFs themselves could be trusted, despite this
information not being entirely uniform.
There was little expectation for much
market change beyond the concentrated bunch
of SEFs currently presiding over FX trades. Just
three respondents expected to see more SEFs
becoming competitive. The long-standing players
that dominate this feld are expected to remain
strong and when it comes to a start-up trying to
break into the limited liquidity in this area, well,
good luck to them.
When it comes to cost there was more
positive news for the FX market; most said the
introduction of SEF rules had not had a cost for
their business. And again the majority thought
costs would remain the same in future, which is
good news indeed when costs are zero.
Majority still trading off-SEF
For the more than two-thirds of respondents
who are yet to trade on a SEF, the reasons were
mostly straightforward.
As a manufacturer, we only do simple
straightforward currency forward contracts
with banks, said one. Company policy was the
reason given by another.
Respondents hailed from all over the world.
One from Algeria said negotiations with banks
were under way to gain access to SEFs.
A number of international respondents did
not know what a SEF was, indicating the scale of
the education efforts that still need to be made
in markets such as India.
Asked what would lead to those who do
not trade on SEFs changing their stance, the most
popular response by far was a rule change to
make trading this way mandatory.
A regulatory requirement. Other than that,
nothing, said one respondent.
Others looked more to internal policy, one
saying instruction by HQ was the only reason
trading would shift to a SEF.
Global trends were also noted as important,
wanting to see others try out the system frst
presumably. Larger trading volumes were also
highlighted as a reason that might make moving
to trading on a SEF viable.
Do you trade FX on a SEF?
Yes 31%
No 69%
Do you trade FX on a SEF?
Yes No
Do you trust the data being gathered about FX trading on-SEF?
0
25%
50%
75%
100%
Do you trust the data being gathered about FX trading on-SEF?
We only do simple
straightforward currency
forward contracts with banks
18
AUGUST 2014
Early in 2014 various types of interest rate
swaps became mandated to trade on SEFs.
As a result this market is seeing very different
uptake of trading on SEFs compared with
FX. However, given the international reach of
this Euromoney report, we had a number of
responses from people who are not trading on
SEFs. What they had to say is interesting and at
times shocking.
One respondent from China said that while
at the moment using SEFs was not necessary,
when trading interest rate swaps in currencies
other than renminbi, not using the facilities might
prove inconvenient in the future.
For Europeans, the decision not to use SEFs
was straightforward. We only invest in euros. We
comply with European regulation, said one. Our
company is based in Europe; we dont trade US
swaps, said another.
A Japanese respondent said quite simply that
the reason he isnt trading on a SEF is because
the installation of SEFs is not required by the
authorities in Japan.
For many it seems a black-and-white
decision: until I have to, I wont. For US persons
however, or those wanting to trade with one,
that time is already here.
Bombshell reasons for trading off-SEF
SEF providers and regulators might be
concerned by some of the responses from those
still avoiding SEFs. Some have ceased trading SEF
vehicles altogether since the regulations became
mandated, fnding other ways to carry out their
business. Even more worryingly, one says he
trades over chat services on Bloomberg. That
works fne, so we see no reason to change
that, he says. In the light of recent events in the
FX market and the impact of chat rooms (on
services such as Bloomberg), though, banks might
be loathed to continue this practice (many have
already stopped).
Lack of instrument coverage was also
highlighted as a reason to stay away from SEFs.
One European respondent lamented not being
able to effciently trade structured IRS swaps
[or] trade packages on SEFs.
Other international respondents indicated
that the volumes they trade do not support
making the move. One said his company lacked
the internal systems to shift and [we] dont do
enough volume to justify [investing in them].
We are a small company, we have a small
fund management operation that does not
INTERNATIONAL PLAYERS SLOW TO ADAPT
Bigger increase in volumes traded on SEF expected over two to fve years than in the next one to
two years
International interest in trading on SEFs is growing but educational efforts must continue
Majority trading on one SEF only; leading to concerns for competition
Trades are still happening over chat functions, side-stepping the tighter SEF regulations altogether
SEF survey results: IRS
Key points
Geographical breakdown of IRS survey respondents
19
AUGUST 2014
require the use of professional tools, said
another.
Why choose to shift to SEFs?
Peer pressure was suggested by one respondent
as being the reason his company would
start trading on SEFs. If more and more
counterparties need to trade IRS on SEFs, it
seems we must choose one SEF to continue
trading. The specifcity of choosing a lone SEF
will interest the market. From the start, the hope
has been of creating a marketplace with as much
competition and choice as there had always
been. But if the arduous process of on-boarding
and slow uptake from the buy side means this
isnt possible, we could end up with a monopoly
of a very small number of SEFs.
Others pointed to regulatory change as
being the only thing that would make them
trade on SEFs. Introduction of mandatory use
of SEFs in Europe, was the only way to get one
respondent interested.
Others wanted to see reliability,
convenience and better prices from SEFs
before making the move.
Greater fexibility [and] meaningful liquidity
beneft leading to changes in portfolio structure,
said another respondent.
We see the potential need to trade SEF
mandated vehicles in the future, but are not
interested [at the moment], said a US market
participant.
The transparency of trading this way was
highlighted as being an attraction, with one
prospective SEF client saying he thought it would
prevent a mistake of order.
Many still choosing to trade off-SEF
As with the FX market, we found the majority
of respondents are yet to trade on SEFs. This
was unexpected in the IRS sector, as certain
instruments have been made available to
trade, which means they have to be traded on
SEFs. However, the answer lies in where our
respondents are based. As the map shows, we
heard from people all over the world, many of
whom will not be touching the US market, and
therefore the Dodd-Frank rules.
In terms of market competition, we were
concerned to discover that most market
participants, even in the more mature IRS market,
are using only one SEF. It is possible they trialled
others before settling on their favourite; more
likely they went to the biggest players, or relied
on existing relationships when the rules came in.
This suggests that start-up SEFs might fnd it hard
to compete, which can only be bad news for
the market in terms of encouraging innovation
in products and technology. Struggles with
innovation were highlighted in the FX survey as
being a big hindrance to newcomers wanting to
join the SEF trading world.
Five-year expectation for notable
increase in volumes
There was a strong majority in answer to the
question about how the percentage of volumes
traded on SEFs would change in the coming
Are global SEF-type rules possible?
No: 75%
Yes: 25%
Are global SEF-type rules possible? (IRS respondents)
Yes No
Did the introduction of SEF rules have a cost for your business?
0
10%
20%
30%
40%
50%
Did the introduction of SEF rules have a cost for your business? (IRS respondents)
years. Market participants clearly expect to see
these increase, presumably as more and more of
the market becomes mandated.
There was a bigger change between the
position now and in fve years than in the next
12 months, indicating a prolonged adoption
period of this way of doing business.
Respondents noted little impact on their
business by the change in rules, with just one
saying the introduction of SEFs had had a
negative impact. And in further good news
for the SEFs and their educational efforts, the
majority were not confused at all about the
process of shifting to trade on SEFs.
International rules a no-go
FX market respondents said they thought
internationally agreed rules might be possible.
Not so for those responding to the IRS survey.
The more experienced IRS market gave a
resounding no answer, demonstrating their
understanding of the diffculties.
Three-quarters of respondents said they
trusted the data being gathered about trading
on SEFs. And the same proportion expected no
change to volumes of trade being concentrated
on a small number of SEFs.
When it comes to cost, those trading IRS in
a mandated environment more often saw a cost
to their business and they also predict a rise in
costs over the next fve years. Perhaps it is a
sign of what is to come for the FX market as
and when more instruments are made available
to trade.

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