Sefs hit by Dodd-Frank disclosure rules

Would-be swap execution facilities (Sefs) are worried about the impact of new business conduct standards requiring swap dealers to provide information to a customer before a trade is concluded.

The rule applies where a dealer knows the identity of a counterparty before execution – as is the case for Sefs that work on a request-for-quote (RFQ) basis and, potentially, for some that offer a central limit order book.

The rules, finalised by the Commodity Futures Trading Commission (CFTC) in February – and due to be implemented from January 1 next year – require a dealer to disclose a swap’s material risks, its economic characteristics and any conflicts of interest on its part. There has been no regulatory guidance or industry agreement on exactly what details should be included, leaving Sefs in limbo – if a platform does not enable the appropriate disclosures, dealers will be unable to trade on it.

“Right now, it’s probably the biggest issue for any of the trading platforms. What we need is an industry agreement about what’s going to be acceptable. We can’t build 80 different versions of these things,” says Wayne Pestone, chief regulatory officer at FXall.

One of the biggest concerns for dealers is a requirement to provide what the CFTC calls a mid-market mark for any trades before execution – defined as the mid-point of the bid and offer, minus the amount added on for profit, counterparty risk, hedging costs, funding and liquidity. Where these trades are executed on a Sef – which should be the case for all standardised products – the platform will need to ensure the dealer is able to provide this information to prospective counterparties.

The method of calculation is expected to differ by product. A senior fixed-income source at one US bank says that for the most liquid forwards, the mid-point will be somewhere between the bid and offer, which he argues are so close together it’s not worth providing an additional value.

For longer-dated swaps, it’s tough to know what is required, says FXall’s Pestone. “What happens when there’s no activity in the thing you want to trade? There may be one or no quotes, so what do you do? It’s not hard to calculate a mid of anything – we just have to know what it is we have to calculate,” he adds.

Once these questions have been answered, Sefs should find it straightforward to implement the process, says Ben Macdonald, global head of fixed income at Bloomberg. “It’s not how the market operates today from a protocol perspective, but it’s technically already possible. For Bloomberg to do that, it’s not a big deal – it would be something we would put into place when the Sef goes live,” he says.

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