Q+A-What’s at stake for swap execution facilities?

By Roberta Rampton

WASHINGTON, Sept 7 (BestGrowthStock) – The fight over who gets to
be a swaps execution facility, or SEF, is shaping up to be one
of the most contentious aspects for implementing the swaps
portion of the new Wall Street reform law.

Here are some of the issues:

WHAT EXACTLY IS A SEF?

Lawmakers insisted on transparent trading for swaps as part
of the effort to decrease systemic financial risks. But because
it can be hard to trade swaps on exchanges, they invented a new
category of regulated market called a swap execution facility.

The law calls it “a trading system or platform in which
multiple participants have the ability to execute or trade
swaps by accepting bids and offers made by multiple
participants in the facility or system, through any means of
interstate commerce.”

“If the word ‘swaps’ was replaced with ‘goods’ this could
be a description of eBay,” wrote Kevin McPartland, an analyst
with TABB Group, in an article submitted to regulators last
month.

What type of business models meet the broad description
given by Congress will be determined by detailed regulations
from the Commodity Futures and Exchange Commission and
Securities and Exchange Commission under tight timelines.

“Until the CFTC actually issues its proposed rules, no one
really knows what a SEF is and what its functionality is going
to be,” said Michael Philipp, partner with Winston & Strawn in
Chicago.

WHO IS WEIGHING IN ON SEFS?

Companies that traditionally have been big players in the
business of trading, facilitating, brokering, dealing and
clearing in the $615 trillion over-the-counter swaps market
today are jostling to ensure they stay in the game.

A large group of dealers including Barclays (BARC.L: ),
Citigroup (C.N: ), Credit Suisse (CGSN.VX: ), Deutsche Bank
(DBKGn.DE: ), Morgan Stanley (MS.N: ) (Read more about the money market today. ) and others had a conference
call with CFTC and SEC regulatory staff last month focused on
key SEF issues.

Some players that have already said they will apply to
regulators to become SEF, including IntercontinentalExchange
Inc (ICE.N: ), BGC Partners (BGCP.O: ), GFI Group (GFIG.O: ), ICAP
(IAP.L: ), Tradition (CFT.S: ), Tullett Prebon (TLPR.L: ),
MarketAxess Holdings (MKTX.O: ), and MarkitServ, owned by
Depository Trust & Clearing Corp (DTCC) and Markit.

Dealers are expected to try to turn private networks into
SEFs, and new players also are expected to emerge.
[ID:nN04258825]

WHAT TYPES OF SWAPS WILL TRADE ON SEFS?

Regulators will define that, too. The new law will require
many types of swaps to be cleared through central
clearinghouses to make the trades less leveraged, lessening
risk. Any swap that clears must trade on an exchange or a SEF.

WHAT’S THE DIFFERENCE BETWEEN AN EXCHANGE AND A SEF?

Exchanges have algorithmic systems for matching up bids and
offers, and open order books. It’s possible some swaps might
trade on exchanges, but many require some element of
customization or negotiation on terms, or are too specialized
to trade on exchanges.

The law’s wording may allow for a broader range of models.
“You may still be able to keep in place some notion of
bilateral consummation of a trade, as opposed to an automated
consummation,” said Joel Telpner, partner with Jones Day in New
York.

HOW WILL SEFS CONNECT TO CLEARINGHOUSES?

The law says clearinghouses can’t discriminate against
swaps executed at unrelated SEFs or exchanges. Some would-be
SEFs are worried clearinghouses affiliated with SEFs or
exchanges will find ways around this “open access” principle
through membership requirements or by preferential fees that
encourage customers to trade and clear in-house.

But clearinghouses have argued that they need to be careful
not to take on too much risk. [ID:nN20127257]

“It all sounds very good on paper to say, ‘Let a thousand
flowers bloom. We’ll have hundreds of SEFs. They’ll all hooked
to a clearinghouse and everything will be great,'” said
Johnathan Short, a senior vice president of ICE, at a
discussion held by regulators last month.

“I think we need to go into this very carefully, and I
think we need to consider how all of this actually bolts
together in the real world and allows the markets to be
properly regulated,” Short said.

WHEN WILL REGULATORS ISSUE PROPOSALS?

Rules for SEFs are to be finalized by next July. To meet
that deadline, regulators have said they hope to propose draft
rules for a host of issues, including SEFs, by mid-December.

But they have a six-month deadline for final rules to
prevent conflicts of interest at SEFs, clearinghouses and
exchanges, such as ownership and voting limits, governance
rules, and access requirements.

(Editing by Lisa Shumaker)

Q+A-What’s at stake for swap execution facilities?