A Familiar Model Emerges for Swaps

By Will Rhode, TABB Group

Originally published on TABB Forum 

The voice provision in the final SEF rules, along with the decision to reduce the request-for-quote requirement, has facilitated the emergence of a business model that can replicate today’s existing workflow for large swaps trades. Over the coming months we will discover where the rubber meets the road of reform and which business models will gain traction. 

In its final Swap Execution Facility (SEF) rules, the Commodity Futures Trading Commission (CFTC) allowed for voice trading, in accordance with the Dodd-Frank provision that swaps trading should occur “by any means of interstate commerce.” In tandem with the additional decision to reduce the request-for-quote (RFQ) requirement to two/three from five, the voice provision has facilitated the emergence of a business model that can replicate today’s existing workflow for large trades. It is called the Voice RFQ SEF.

A Voice RFQ SEF represents the most familiar trading protocol for many buy-side and sell-side traders who wish to continue transacting in size. Size discovery is easier over the phone than on electronic platforms, where trade sizes are significantly smaller. Interdealer-brokers (IDBs) would seem to be the best positioned to launch Voice RFQ SEFs since much of their business is voice-based already. Given their wholesale roots, they also can demonstrate a high degree of liquidity as well as the ability to execute in size. However, they still face the challenge of getting the buy side onto their platforms.

Some question how a Voice RFQ SEF fits with the original G20 agreement of 2009: “All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms.” It would be easy to see why those who have waited more than three years to challenge the traditional swaps players might feel a sense of dread. The finalization of the SEF rules on May 16 has widely been expected to herald a new era in swaps trading, with more transparent, electronic, order-driven and open-access markets facilitating competitive, multilateral trading.

Over the coming months we will discover where the rubber meets the road of reform – which business models will gain traction? Nearly all of the 165 participants in TABB Group’s recent “SEF Industry Barometer: Summer 2013” study believe that an active order book will have emerged in rates by 2015. At the same time, however, they also believe that 24% of the overall swaps market will be conducted via voice RFQ. The preservation of a trading protocol that closely resembles existing trading practices means that exchange-like trading in swaps will only now occur through gradual changes in participant behavior and regulatory refinement of the SEF and exchange rules.

The last TABB Group SEF Industry Barometer was published in December 2011, outlining the industry’s stance on the key issues and highlighting those SEFs expected to be successful. Today, it serves as our benchmark, not only in terms of who will win and who may lose, but also in terms of the issues that were resolved and those that were not. We can also see how the market has shifted and acclimatized to new concepts with the passage of time.