Clients feel forgotten by Giancarlo’s swaps trading plans

Industry says wider Sef mandate ignores reality of dealer-to-client market

  • Christopher Giancarlo is racing to pass a set of reforms to US swap execution facility (Sef) rules before he leaves office, probably this year.
  • But clients are concerned the expansion of the trading mandate and broader definition of trading protocols on Sefs do not take account of current dealer-to-client trading techniques.
  • In particular, there are concerns that relatively illiquid instruments could be forced on to Sefs, with only the interdealer market possessing the voice-trading capacity to take advantage of their inclusion.
  • Proposed rules to restrict trades pre-executed and then moved on-Sef could force foreign brokers to register with the CFTC, and further prevent clients from accessing Sefs.
  • There are also expectations that the reforms will dampen the use of central limit order books, which clients and non-banks are already struggling to access.

For a man with not long left in power, Christopher Giancarlo has his work cut out. The chairman of the Commodity Futures Trading Commission (CFTC), whom some experts say might be out of office come late April, is facing a backlash over his long-awaited proposals to reform how derivatives trade.

Signposted by two public whitepapers, one as a commissioner in 2015 and another as chairman last year, Giancarlo has long been a public critic of how the original rules governing swap execution facilities (Sefs) – regulated platforms for swaps trading – are written.

But, with just months left as the steward of the CFTC, the chairman’s 700-plus-page flagship proposal on how to correct what he sees as a “flawed implementation” of the Dodd-Frank Act’s trading rules has missed the mark for end-users. That’s the view shared by 11 firms that spoke with – including banks, asset managers and Sefs.

The vast majority interviewed take issue with the regulator’s attempt to widen the scope of products and trading protocols for swaps mandated to trade on-Sef. They fear the proposals fail to appreciate the intricacies of how the dealer-to-client market works.

“This is a proposal written for the interdealer market and it has forgotten the dealer-to-client market operates very differently,” says a market structure expert at a bank.

While the interdealer market features voice brokers to help intermediate less liquid trades that would be brought into scope under this proposal, this concept does not exist in the electronic dealer-to-client market, participants say, and it would be a step backwards if adopted.

“I don’t think the right thing to do is introduce voice brokers to intermediate trades for clients. It’s just one of the unintended consequences of issuing a proposal geared towards fixing problems in the interdealer market,” the expert says.

Our view is there should be some form of liquidity check before something is deemed MAT
Supurna Vedbrat, BlackRock

The head of trading at BlackRock agrees. Supurna Vedbrat says swaps legally determined to trade on-Sef, known as made-available-to-trade (MAT), should face a litmus test to measure liquidity before being indiscriminately forced on to a Sef, which in the dealer-to-client market is a fully electronic environment.

Supurna Vedbrat

“We have to be very mindful as an industry that when we have a product that is mandated to trade electronically, there is enough liquidity in that particular product. Our view is there should be some form of liquidity check before something is deemed MAT,” she says. 

Other pushback from market participants has centred on the pre-trade communication and impartial access proposals, which Giancarlo admitted, in a speech on January 25, had triggered “valid concerns”.

Some businesses have even questioned the industry’s appetite for making changes to the current infrastructure, given the market is now settled. Since the initial rocky roll-out of the original Sef rules under former CFTC chairman Gary Gensler, end-users largely feel the market has become better, even if not perfect.

For example, buy-side firms say the bid-offer in swap contracts has shrunk due to increased electronic trading, there is more automation in trading and workflow, and there is new competition in the form of non-bank market-makers such as Citadel Securities, which made a real impact when they entered the marketplace.

However, the CFTC argues the current Sef rules need refining and rejects the notion it has misunderstood how clients operate in the swaps market today.

“There is strong agreement among market participants that the current Sef rules are mismatched to the episodic nature of swaps liquidity, biased against innovation and unduly complex. In designing the proposed rules, we took into account the trading dynamics and unique characteristics of both the dealer-to-client and interdealer markets,” wrote a CFTC spokesperson in an emailed statement to

Make the call

The past six years of the Sef regime have barely been without controversy. When the rules were first adopted in 2013, as part of the Dodd-Frank Act reforms in the wake of the financial crisis, there were plenty of grumblings from market participants about the fine print.

The rules gave responsibility for deciding which products should be MAT to the Sefs themselves. The rules dictate that once a Sef files for a product to be MAT and the CFTC rubber-stamps the approval, a product can only be executed on-Sef, unless a transaction is big enough to qualify as a block trade.

Javelin Capital Markets, a start-up Sef rather than an established trading platform, filed the first MAT determination on October 18, 2013.

The move by Javelin ruffled feathers at the time, and some Sefs still insist they do not want to bear the responsibility of making a MAT determination now or in the future.

“Asking trading venues to make the call for what is mandatory trading, as opposed to a different approach, is not the right call,” says a legal expert at one Sef operator.

But that reluctance has also created an impasse in moving new products on-Sef. Buy-side firms attest there are numerous products, including inflation swaps, swaptions, NDFs and credit default swaps that trade electronically today and could be moved on-Sef with little operational effort.

Asking trading venues to make the call for what is mandatory trading, as opposed to a different approach, is not the right call
Legal expert at one Sef operator

That list expands further at other Sefs. understands trueEX, a dealer-to-client Sef that is in the midst of a lawsuit against 11 banks, already offers electronic swaps trading in currencies such as the Brazilian real and Mexican peso, with five and seven liquidity providers respectively in each currency.

The CFTC has attempted to navigate these murky waters in the current proposals by determining that any product mandated to centrally clear at a central counterparty (CCP) should also have to trade on-Sef. 

Today, few products in the interest rate swap suite of products are actually mandated to trade on-Sef. The ones that are include fixed-to-floating US dollar swaps in spot-starting and International Monetary Market (IMM) formats, and spot-starting trades in euro and sterling. 

Taking all products mandated to clear at a CCP would widen the scope to basis swaps, forward rate agreements (FRAs) and overnight-indexed swaps (OIS), and across 10 additional currencies in vanilla swaps, including the yen, Swiss franc and Canadian dollar.

One interdealer broker that operates a Sef has applauded that approach.

“What is being proposed will help innovation because there are methods of execution that we haven’t even thought of yet. In two to three years’ time someone might come out with something new, but in the meantime you can’t push a market towards electronic execution, as the current rules try to do,” says the broker.

The original Sef rules also attracted controversy over how the platforms themselves would operate. Despite many market participants translating the Dodd-Frank language of “any means of interstate commerce” as signalling a non-prescriptive style of trading, the CFTC dictated that a Sef must operate a central limit order book (Clob) and a request-for-quote (RFQ) system – a move consistently criticised by Giancarlo.

“Congress did not create confusing artificial distinctions for swaps trading nor did it create a detailed regulatory mandate around which swaps must be executed on Sefs,” he argued in a speech at an industry conference in November 2014, several months after being confirmed as a CFTC commissioner.

His Sef reform plan has therefore proposed expanding the trading protocol beyond just a Clob or RFQ

Illiquid markets

However, proposing the rule in this way creates unintended consequences for the dealer-to-client market, say investors. spoke to five US-based buy-side firms with assets under management of roughly $12.5 trillion, who agreed that placing all cleared swaps on-Sef would cause difficulties for illiquid trades.

“For thinly traded swaps that’s a big problem,” says a senior trader at one asset manager.

Banks agree. An electronic trading head at one US bank says that even though some historic credit default swap indices (CDX) are mandated to clear, they are not really appropriate for Sef trading, even if some trades might get processed electronically.

“Liquidity often comes in spurts and then a month later it dies out. A lot of off-the-run products are arranged bilaterally, but then use the platforms to process the trade electronically, because you can use the Sef’s technology and operations to pre-clear all the credit checks, do confirmations and send the trade to the CCP,” the trader says.

The issue centres on the fact that banks trading in the interdealer market use voice brokers to handle their trades and can continue to operate in the same manner, even with more trades falling into scope.

However, the dealer-to-client trading platforms, such as Bloomberg and Tradeweb, are fully electronic. To conform to the rules as proposed, those venues would have to hire a fleet of voice brokers to help facilitate illiquid trades or the banks – which still facilitate off-Sef trades for clients directly over the phone – would have to register as Sefs.

Neither camp wants to go down that route. “We would have no interest in setting up a Sef entity,” says the market structure expert at the bank. “There’s just no incentive, given the compliance, technology and operational costs involved.”

No introductions

The issue is coupled with the requirement in the proposal to “limit the ability of market participants to conduct pre-execution communications” and stop the submitting of those trades via a Sef, which is how many illiquid trades are executed today.

The move by the CFTC has been translated by participants as an attempt to shut down the introducing broker model set up by interdealer brokers in the wake of the original Sef rules. That concept was used to allow brokers sitting outside the US to continue arranging trades to be executed on-Sef between foreign entities and US persons. It was also used as a workaround to the Sef rules.

For brokers’ foreign entities, the rule changes are “potentially problematic”, according to a second interdealer broker. In regions such as Asia, there would be heavy operational work to go through the regulatory process in order to handle a relatively small volume of trading.

It does not make sense to make offshore brokers move on-Sef
Second interdealer broker

“We’d have to establish branch offices that would have to house the on-Sef brokers,” the broker says. “It does not make sense to make offshore brokers move on-Sef, which is highlighted by the fact we now have equivalence with the European Union and the US is likely to have that same determination with the Asia-Pacific region as well.”

While moving voice-brokers inside a CFTC-regulated entity provides a route for interdealer brokers to conduct pre-trade executions, once again that same concept does not exist for the dealer-to-client market.

“There is ambiguity around what would count as a pre-trade communication and it could give an unfair advantage to Sefs that have pre-existing chat functionality,” says the market structure expert.

Bloomberg offers the most widely used electronic chat functionality, but Tradeweb, the largest dealer-to-client Sef by average daily volume, does not have anything that would be applicable to this rule proposal.

“Forget whether it’s a good or bad idea; for market participants and their workflows, this will have a major impact on how things get done,” says the Sef legal expert.

More trouble than it’s worth

In short, participants using the dealer-to-client market are not up for huge disruption to how they currently conduct business. They have, by and large, taken to the more automated nature of swaps trading via the RFQ protocol, which has helped to slash the time it takes to trade significantly.

“Pre-Sef, trading a list of 20 swaps would take half a day. Now, that takes a matter of minutes,” says the senior trader at the asset manager. “Sef liquidity provision in the dealer-to-client market has really been robust and transparent, with better price discovery, build-up of liquidity and standardisation. Clients have been very happy with the Sef experience.”

For the most part, participants are concerned about the huge effort that would be involved in implementing the proposals as written – particularly if the current chairman is not around to maintain momentum for their completion. A widespread preference is to codify some of the outstanding no-action letters that have kept the house of cards in place to date, which would likely garner more industry support.

Some take a more exasperated tone about the whole Sef project.

“In all honesty, if we had just cleared and reported every trade, we would be in the exact same spot we are [in] now and would have saved hundreds of millions of dollars for the banks, brokers, the regulator, everyone… nothing has changed whatsoever,” the broker says.

Split liquidity pools

One of the main complaints from trading platforms about the original Sef rules centred on Footnote 88, which required any venue to register as a Sef if it operated “in a manner that meets the Sef definition” – even if the products it allowed to trade were not part of the MAT requirement.

This resulted in numerous foreign exchange platforms scrambling to register at the last minute. The world’s largest asset manager, BlackRock, made the decision to step away from electronic venues facilitating non-deliverable forward (NDF) trading and return to voice trading instead, as it felt signing up to those venues was not a good use of resources.

Scott O’Malia

The rule also forced non-US based trading platforms to turn away US customers out of fear they would be forced to register as a Sef. This meant separate liquidity pools formed as US persons were required to clear trade products on-Sef, while non-US persons were not subject to equivalent rules at that time.

According to the International Swaps and Derivatives Association (Isda), this caused euro swaps liquidity to coalesce solely around European dealers, whereas the market had previously seen roughly 25% of activity involve a US dealer.

Even a trading equivalence deal between the CFTC and the European Commission, signed in November 2017, has done little to repair that liquidity split, Isda chief executive Scott O’Malia said last year.

The electronic trading head at the US bank says the source of fragmentation of the global swaps market can be traced back to the introduction of Footnote 88, and he is not confident the proposal “goes far enough” in amending that language.


There is one apparent failure of the existing Sef system that some market participants are genuinely keen for the CFTC to address.

Clobs, which are a required trading feature for all Sefs under the current rules, have not taken off in the dealer-to-client market. Efforts to gain access to those Clobs operated by Tradition and TP Icap in the interdealer market have yielded no success, to the disappointment of some firms that would like additional trading options.

“There could be certain situations in which we would like to be a price-maker on a Clob,” says BlackRock’s Vedbrat. “To be clear, I don’t see a lot of our liquidity moving to a Clob and that’s where the concern is from other market participants. It would just be one form of trading for us and it would be dependent on certain market conditions.”

For those buy-side firms that have been keen to see liquidity in Clobs develop, the Giancarlo proposals have made that dream unlikely to happen, given that the CFTC does not want to define trading protocols for the industry, say investors. They attest the Clob is likely to disappear if it is not mandated under regulation, keeping the market two-tiered, with banks operating in one pool and clients in another.

Even before the dawn of the Sef regime, the swaps market operated exactly that way. With the notable exception of Citadel Securities, no other firms have managed to muscle into the dealer-only liquidity pool, despite the current Sef rules requiring impartial access.

Depending on who is asked, the blame for a lack of diversity in liquidity pools ranges from the banks to the Sefs and to buy-side firms. The practice known as post-trade name give-up, whereby the names of both counterparties to a trade are disclosed after it, has been often maligned for its role in keeping non-banks out of the interdealer market.

Market participants say banks are nervous that clients will use information obtained in the interdealer market while requesting prices in the dealer-to-client sphere, and potentially move the market in their favour as well.

Even Citadel Securities faced some pushback when it first joined that market. The CFTC is currently seeking comment from the industry on this practice.

But concerns have been raised about language in the new proposals that appears to “codify” the market split. The rules “would allow a Sef to structure participation criteria and trading practices” – interpreted by market participants to mean a Sef could dictate which types of entities are allowed to trade in each of their liquidity pools.

The interdealer broker Sef operator has welcomed this proposal: “We should be able to decide who we do business with, whether that’s buy side only or interdealer only – that’s fine. As proposed, the impartial access rule isn’t detrimental to anyone.”

Buy-side firms disagree. They say the idea that firms could be locked out of a marketplace is disconcerting.

“We like the idea of not limiting ourselves in any way. The point is to have options. The fear is the door to access becomes closed and locked. We don’t want things happening in the inter-broker-dealer space that are less transparent. Don’t shut out buy-side shops that may have an interest in participating in those liquidity pools,” says Lisa Cavallari, director of derivatives trading at Russell Investments.

The idea of other non-bank market-makers being shut out of some liquidity pools hardly reassures investment firms that Giancarlo’s plan will lead to more competition in the swaps world.

“We want non-dealer liquidity providers to have access to Sefs because they have been very proactive in providing liquidity and being competitive, which has been good for all market investors. They have also forced dealers to be competitive, too,” says the senior trader at the asset manager.

This is the second of two articles looking at the future of the Sef rules. For the first article, please see here.

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