Article: SEFCON V 2014: No Shortage of Strong Opinions as Regulatory and Market Structure Uncertainty Dominates Discussions

21 November 2014 | Sapient Feed

Paul Gibson attended SEFCON V on November 13. Prior to the conference, he captured his thoughts in the blog: Swap Execution Facilities are still establishing their place in the new OTC market structure: Will SEFCON V 2014 move them in the right direction? Here, he reports on the key themes from the conference, the sentiment of attendees and predictions for 2015.

SEFCON V 2014 kicked off with a bang. No sooner had Chris Ferreri, CEO of ICAP and Chairman of the WMBAA, announced to the 350 attendees that “everything was on the record” were the gloves off in a sparring match between two heavy weights in the trading world.

Designed to discuss what the industry had learned from the first year of SEF trading, session one became a heated debate between representatives from Bloomberg’s SEF and UBS’s SEF aggregator, Neo. Disagreement centered around the lack of participation on SEF’s central limit order book (CLOB). Bloomberg claim participants prefer the traditional “request for quote” model, a seamless STP workflow, from execution to clearing to reporting as well as pre- and post-trade analytics and aggregators have little to no volume because they add little value. UBS contends that clients would use the CLOB on an anonymous basis if Bloomberg allowed it. Along with Morgan Stanley and Credit Suisse, these firms propose aggregation because they think the model offers everything the SEFs have, as well as best execution across SEFs and access to other services such as central clearing houses and regulatory expertise. Plus, the aggregation model removes the legal, operational and technical hurdles that the sell side faced when ramping up to trade on SEFs.

Even if this area of contention is resolved by the regulator, the required standardization for CLOB trading on SEF is not yet present for the majority of OTC derivatives. With the formation of numerous industry working groups around symbology and connectivity, the technical potential for a shift to the CLOB is becoming a reality. In this context a SEF aggregator would become more interesting. According to PIMCO, the traditional buy side is likely to be agnostic toward trading venues and instead would leverage the technical hurdles being overcome by the CCPs. The debate, in many ways, may signify a shift: regulation is taking a back seat again and real competition is being re-established as the main driver in this deeply capitalistic industry. Once the technology is available, the outcome of the access debate will likely decide the direction for the OTC market structure. At the moment, however, it remains unclear who the winners and losers will be.

Scott O’Malia used ISDA’s well-known research to open a discussion on cross-border issues. He attempted to prove that the SEF rules have bifurcated liquidity in the Interest Rate Swap market between the US and Europe and the panel agreed.

Dexter Senft, Morgan Stanley: “The CFTC were the first movers in passing the Electronic Execution rules, they “didn’t get a 100% on the test”

With both regulators, ex-regulators and bankers all in agreement that fractured liquidity across the OTC market is a reality, the discussion shifted to how to bring these markets back together through equivalency: MFTs and OTFs under MiFID II/ MiFIR. Edwin Schooling Later promised draft technical standards “as an early Christmas present.”

Edwin Schooling Later, FCA: “Bifurcation of liquidity between Europe and US a ‘tragic outcome”

There was a consensus that the European rules will open markets in Europe that are currently not overly accessible for US-based market makers. Agreement was lacking on how to implement equivalency. Until equivalency rules are enforced, it seems likely the industry will see further liquidity bifurcation with little appetite for more voluntary SEF trading. Alternatively, if 2015 is the year of innovation and a new market structure becomes more attractive to participants, we may see liquidity return even before equivalency trading rules in Europe.

John Shay, Virtu Financial: “The Euro Market liquidity is more of a club like access vs. open client access”

Regulatory uncertainty and market structure change were the key, inextricably linked themes of the day. How participants, especially the buy side, will trade in the OTC market going forward is unclear due to regulatory uncertainty leading to conflicting interpretations of SEF rules in a competitive market.
If 2014 was the year of building the ability to trade on SEFs and, if the industry receives regulatory harmonization and clarity, then 2015 is likely to be the year of catch up innovation and competition. It was clear that firms will always take the path of least resistance for SEF execution and market harmonization.

Before the end of session one, the panel offered its predictions for 2015:

1. Cross-border cooperation: The CFTC will be more flexible with their rules and will avoid a more fractured liquidity marketplace with more substituted compliance.
2. Central clearing: Workflows will become more efficient.
3. Non-deliverable forwards (NDFs): These will become made available to trade. (This prediction slightly contradicted the first)
4. Access: Greater clarity will come from regulators regarding impartial access and anonymity.
5. Volatility and liquidity: These will come back into the market and help with financial stability.
6. Data: Quality and transparency will become a focus area.
7. Asia: The ripple effect of SEFs to Asia/Japan will come into focus in late 2015.

Despite Chairman Massad’s conciliatory tone, by the close of the day, the list read much more like an early holiday wish-list than a realistic set of predictions. Only time will tell.

You can read more about these topics in the following CROSSINGS articles:
MIFID II: harmonization mandates new business models in the OTC space
SWAP EXECUTION FACILITIES: a catalyst for OTC market change?


About Paul Gibson

Paul Gibson is a Business Consultant based in New York  specializing in capital market initiatives. He is currently working at a top European investment bank focused on the impacts of regulatory reform on execution, clearing and reporting workflows. Prior to this, Paul spent time at a top market infrastructure provider, initiating a cross-asset industry project designed to facilitate the reporting of OTC derivatives to a global trade repository.