SEF Compliance Amid Regulatory Turbulence
The new world of SEF execution will cause market participants to reassess swap trading operations, workflows and IT infrastructures.
upon participants in swaps transactions. A key mandate is the requirement that most swaps be subject to trading systems known as swap execution facilities (SEFs), which will facilitate transactions by accepting bids and offers from market participants. DoddFrank has also mandated central clearing for many types of swaps (see figure 1.) Overall, most swaps market participants will have to comply with a new and demanding regulatory environment. The reforms underway for swaps trading are creating multiple challenges for financial services firms as they race to meet the demands of regulators, internal business groups and competitors. In the U.S., the Dodd-Frank Act imposes transparency, record-keeping and audit trails, and swaps data regulatory reporting

For firms to remain competitive, they will need to rapidly expand their technology infrastructure to facilitate compliance in today’s fastchanging regulatory landscape.

Regulators are pushing swapsmarket market participants toward clearing clearing Regulators are pushing swaps participants toward

21% 57%

2008 43% 79%
21 percent of the $340 Trillion market for Interest Rate Swaps was cleared


57 percent of the $340 Trillion market for Interest Rate Swaps was cleared Source: CFTC

Source: CFTC

SEF Compliance Amid Regulatory Turbulence SEFs DEFINED

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Are a regulated platform for swap trading that provides pre-trade information (bids and offers) and an execution mechanism for swap transactions among eligible participants. The regulated trading of certain swaps is a result of requirements in the United States by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The new world of executed swaps is compelling firms to quickly find ways to costeffectively manage their SEF interactions as well as bilateral, exchange-traded and cleared transactions. Firms will have to revisit their relationships and workflows with counterparties and other market players. They will also have to review their trading, risk management and compliance platforms, possibly revamping operations, workflows and IT infrastructures.

orders and guidances that form the backbone for a new market structure.

Getting to this new world of execution requires a maze-like process of rulemaking with many key rules still pending.

The new rules for clearing and execution are advancing, if not in unison. The clearing of interest rate and credit index swaps for swap dealers, hedge funds and other financial institutions was up and running during the first month of the launch of nearly 20 pioneering SEFs. However, some SEFs that were among the first movers had trouble meeting the October 2 deadline to begin operations In order for firms to remain competitive, they because of regulatory confusion. The CFTC will need to rapidly expand their technology had to give them another month to become infrastructure to facilitate compliance in operational. today’s  fast-changing regulatory landscape. Treasurers serve as financial risk managers that seek to protect athe company's value from theregulatory financial Despite confounding risks it faces from its business activities. Because these risks can arise from many sources, the role whirlwind, industry players are complying. requires an understanding of many areas of business and the ability to communicate with a variety Swaps Market Participants Push Gary Gensler, the outgoing chairman of of financial professionals. Once an offshoot of the accounting department, corporate treasury the CFTC, reported that 80 percent of new Ahead management has evolved into its own company department and professional body. interest rate swaps were being cleared under In the wake of new regulations stemming the new rules and regulations. As of Oct. from Dodd-Frank, swaps dealers and their 25, 2013, $190 trillion of the approximately clients are diving into the new environment $340 trillion market-facing interest rate swaps of SEF-executed OTC transactions that have market, or 57 percent, was cleared, compared been established and approved under the to 21 percent of the market in 2008, according CREDIT OPERATIONAL CURRENCY INTEREST RATE U.S. Commodity Futures LIQUIDITY Trading Commission RISK RISK CFTC. In RISK RISK RISK to the addition, swaps data TREASURER (CFTC). The new environment for executed repositories are filling up as data on $400 swaps is likely to spur many discussions for a trillion in market-facing swaps is being fed variety of firms. Buy-side firms, for instance, into repositories, according to CFTC reports. such as large asset managers are considering At the same time, new regimes for valuations, how many SEF connections they need or margining and collateral management are whether they should work with a bank or taking hold. President Obama nominated other firm that will cost-effectively aggregate Timothy Massad, overseer of the Troubled SEF links. The newly minted SEFs are Asset Relief Program, to replace Gensler who struggling to define the instruments they will stepped down in January 2014. As Massad have to accommodate, including cleared and awaits Senate approval, the CFTC appointed non-cleared instruments, OTC and bilateral Commissioner Mark P. Wetjen to be the acting transactions, all of which will require new chairman of the agency. workflows, operations and IT support. Although their goals may be temporarily Yet to get to this seemingly straightforward deferred, regulators are pushing to achieve a new world of execution requires a maze-like new transparency in the pre-trade and postprocess of rulemaking with many key reforms trade processes that parallels the strides they still pending. At last count in October 2013, have made in centralized clearing services. the CFTC with feedback from the industry has been refining and ushering in 62 final rules,

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SEF Compliance Amid Regulatory Turbulence

OpenLink - Insights trade” (MAT) rules. Final decisions are slated for early 2014 as SEFs themselves have been putting forth proposals about the types of swaps they would prefer to transact. The CFTC has set the criteria for the proposals, asking how many ready and willing buyers and sellers there are for a particular swap, the frequency and size of those transactions, the trading volumes expected, the anticipated number and types of market participants, the bid/ask spread and what the expectations are for the number of resting firm or indicative bids/offers.

An Inauspicious Start
Yet it was hardly a smooth transition. The CFTC has been having a contentious transition to SEF-executed swap transactions. To its credit, the CFTC has been persistent in proposing and refining rules and deadlines, and has been unrelenting in keeping the industry on course with OTC reforms. One of the regulator’s key actions has been to steadily process and allow a wide range of market participants to temporarily register as SEFs. The applicants have ranged from the IntercontinentalExchange (ICE), which launched ICE Swap Trade to interdealer broker ICAP, which brought forward ICAP SEF. In addition, market data terminal, news and systems vendor Bloomberg was the first to get approval for a multi-asset SEF. But complications continued.

The CFTC has been having a contentious transition to SEFexecuted swap transactions.

The CFTC is refining its “made available to trade” rules to govern the kind of instruments to be processed via SEFs.

In mid-January 2014, the CFTC certified the MAT determinations proposed by the Javelin SEF, a subsidiary of Javelin Capital Markets, which cover interest rate swaps. The approval means that mandatory trading of swaps via SEFs or exchanges (DCMs) will start on Feb. 16, 2014, and will conform to Javelin’s MAT Several key market participants such as rules, unless participants are exempt or the options platform providers needed a transaction is a block trade, according to the deadline extension because of the CFTC’s CFTC. much publicized “Footnote 88” surprise to The Javelin MAT rules govern U.S. dollar and the approved SEF rules. In short, the CFTC Euro-denominated interest rate swaps with requires many-to-many trading platforms the following maturities: 2 year, 3 year, 5 year, that act much like SEFs to register as SEFs 7 year, 10 year, 12 year, 15 year, 20 year and and to meet the new compliance rules. Yet 30 year. The Javelin MAT determinations also the eleventh hour discovery of the footnote certify certain forward or IMM interest rate forced platform providers to scramble to swaps. get clients onboard and to revamp their infrastructures, ultimately causing the CFTC The CFTC is considering other MAT proposals to move the initial early October deadline to such as those from MarketAxess covering early November. credit default swaps, trueEX for interest rates and Tradeweb and Bloomberg on credit and Making matters worse, the 16-day federal rates instruments. government shutdown that stretched from mid-September to mid-October 2013 While the final MAT rules will compel DCMs hampered the CFTC’s efforts and at the same and SEFs to execute the mandated swaps, the time spurred it into action. The shutdown rule has an inherent, if far off, expiration date. caused the regulator to issue guidances and “A swap that has been deemed available to other actions on the eve of the shutdown that trade will remain subject to the trade execution created more confusion than clarity. Ultimately, requirement until all SEFs and DCMs that the industry had to wait until the end of the had listed or offered that swap for trading, shutdown to resolve several questions and including the SEF or DCM that submitted the concerns. Firms hoping to launch themselves available-to-trade determination, no longer as SEFs had to wait until the shutdown was list or offer the swap for trading,” the CFTC over before they could proceed. says in its most recent fact sheet on the issue.

What Swaps Will Be Made Available SEFs have too much sway over the process to Trade? and want swaps dealers, futures commission

Some critics of the process are concerned that

Regardless of the shutdown, the CFTC has merchants (FCMs), central counterparty been actively refining its “made available to clearinghouses (CCPs), and buy-side firms to January 2014 - White Paper #8 Page 3

SEF Compliance Amid Regulatory Turbulence

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Swaps market participants will not be able to avoid new costs and stresses.

have a greater role in the process. The CFTC Infrastructures Under Stress will determine the final content of the MAT Swaps market participants will not be able to rules after a 90-day review process for each avoid new costs and stresses. proposal and after gathering comments from industry participants. The rigors of mandated execution for swaps cut across the traditional front-to-back office barriers and require market participants The Agency Model to reassess their current IT infrastructures While the MAT designation is being debated, and operations for the interest rate, credit, the CFTC has embraced an agency-style, currency, equity and commodity asset classes. aggregator model for SEF connectivity that is intended to insure that SEFs, many of whom Firms will have to rethink trade capture, are major dealers, maintain a level playing valuation, compliance and limits monitoring, confirmations and affirmations, transaction field for swaps market participants. enrichment, regulatory reporting, position By allowing the aggregation of SEF and risk reporting, collateral management, connectivity, the regulator is of hoping to Major Areas Risk for Multinational accounting,Corporations and cash management. The prevent a closed, dealer-to-dealer market execution and clearing reforms will also The enterprise risk systems and operations of non-financial MNCs will have to as some of the first SEFs were seen challenges as impact take on many exposure across key trading areas. settlement, accounting, treasury imposing restrictions on market participants management and regulatory reporting reminiscent of market conditions before the processes. Great Recession.







The regulator is also adding an element of disintermediation as the decision will allow banks to provide aggregated SEF links to many pools of liquidity, which could create new competition for established dealers. The support for aggregation will also allow market participants such as buy-side firms to sidestep the need and costs (see figure 2) of SEF membership.

The goal for many firms will be finding the right mix of operations, workflows and IT to manage a far more complex swaps execution environment that could include bilateral, cleared and non-cleared, exchange-traded and OTC instruments. Processing this variety of swaps will be greatly hampered by fragmented IT systems, operations and workflows. Autonomous applications for trading and risk management Page 4

January 2014 - White Paper #8

SEF Compliance Amid Regulatory Turbulence that are either not integrated or poorly connected could prevent firms from streamlining operations and achieving an enterprise-wide view of exposure potential. Disparate systems can complicate and delay matters for traders and risk managers. Staff workflows can also be disjointed especially when tasks are completed without a single, consistent set of information. In addition, data transfers among autonomous systems are error prone, causing delays via corrections, reconciliations or in worst case scenarios, broken and failed transactions. Firms that want to know their swap trading positions in real time will find this situation difficult.

OpenLink - Insights Market participants will also have to reconcile the thorny issue of connectivity to SEFs, which is costly and will incur demands for gathering execution details and pre-execution compliance. While the CFTC has sanctioned the creation of SEF connectivity aggregators, it is unclear at this stage whether banks (or other market players) are willing and eager to take on this responsibility. It is also unknown what kind of demand exists for such a service. Whether firms aggregate SEF links via a third-party or on their own, they will have to gather data in an attempt to achieve price transparency among the SEF providers and compile clearing details. They will also have to uncover credit availability and order

Disparate trading systems can complicate and delay matters for traders and risk managers.







Other workflow issues are challenging firms such as the streamlining of the capture of executed trades, gathering fill details, making allocations, establishing clearing statuses and certainty of clearing, and swap data repository (SDR) reporting. There will also be new operational and compliance demands for market participants such as the confirmation of executions and overall compliance with internal policies. In addition, SEF membership will require market participants to take on new, burdensome record-keeping and auditing responsibilities to meet regulators’ needs.

status, compile SDR reporting details, and monitor CFTC position limits. With an eye to the ongoing struggle to achieve operational efficiency in swaps execution, firms will also have to constantly review, streamline and refine their SDR reporting and record-keeping processes (see figure 3).

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SEF Compliance Amid Regulatory Turbulence

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Conclusion: A Unified Core for SEF A holistic workflow can ultimately serve as the foundation for optimal operational efficiency. Execution
From a unified core, firms will be able to manage multiple SEF connections, execution and fill details, and clearing statuses while aiming to streamline the capture of executed trades. A unified approach also helps firms face complex price aggregation across SEFs that will enable strategic price comparisons of the execution venues. It will also help firms conduct a pre-trade analysis of the most costMost firms fail to maximize their use of cash and effective clearing venues (FCMs and CCPs), collateral because of an incomplete view of taking into consideration initial margin, fees securities and because cash is often harbored and related costs. in discrete sections of the organization. Given The analysis should also include actionable the new regulations and the related new prices retrieved via central limit order book collateral demands, firms will need a way to (CLOB) and request for quote (RFQ) execution efficiently monitor incoming and outgoing methodologies, and will help firms as they collateral, and to value collateral using market formulate CLOB and/or RFQ strategies. standard models and data sources. A unified and integrated approach is also effective It’s likely that firms will need to apply new IT for optimal management of post-execution support, operations and workflow processes operations such selective netting, portfolio to encompass the full lifecycle of SEFbased execution, including SEF connectivity compression, and post-clearing allocations. and swaps transaction management. A comprehensive, unified approach will help ease the major burdens that market participants face in complying with regulators, satisfying internal trading needs and staying ahead of the competition. In the new world of swaps trading, market participants will need tools and workflows to help them adjust to the new regime of SEF execution, which has been made more challenging and expensive because of the shifting regulatory requirements. A centralized core would help firms adjust to these demands.

OpenLink is committed to staying at the forefront of regulatory reform, working closely with clients, regulatory agencies, clearing houses, clearing members, service providers and trade data repositories to keep pace with the rapidly evolving derivatives landscape. OpenLink continues to provide leading technology solutions for the energy and financial services markets with its suite of regulatory compliance software. For more information, please visit our Regulatory Compliance page at For further information, please contact OpenLink’s Subject Matter Expert, Phil Wang.

OpenLink - Marketing and Communications Phone: +1 516 833 4509 1502 RXR Plaza 15th Floor — West Tower Uniondale, NY 11556 United States
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December 2013 - White Paper #8

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