The Securities and Exchange Commission on Wednesday proposed rules for trading swaps that differ from those being considered by its fellow US market regulator, the Commodity Futures Trading Commission.
The rules for “swap execution facilities”, or SEFs, are hugely important in determining the way derivatives markets function in the future and whether entities – such as Wall Street derivatives dealers – capture trading activity.
The SEC, whose rules were proposed after the CFTC put its rules forward in December, said a SEF for derivatives which it will regulate such as single name credit default swaps would accommodate a “request for quote”, or RFQ, system.
Under its proposal, a potential buyer or seller of a swap could seek a price from all participants, or choose to send it to fewer.
In effect, the SEC rule means that SEFs for single name CDS could adhere to the current market practice of an RFQ being sent to a single dealer.
That raises questions as to whether the spirit of the Dodd-Frank Act would be applied in such a case, since the financial reform legislation mandates that swap prices be streamed to many participants.
A director in credit trading at a large bank said: “The SEC is taking the right approach with respect to RFQ by allowing the client to decide what is in their best interest to get best execution. If that means all or only one, they are allowed to make that decision.”
Under proposed CFTC rules for SEFs covering interest rate swaps and credit indices, a RFQ must be sent to at least five dealers.
Some of the large derivatives dealers have said that sending a RFQ to five dealers would compromise liquidity in the swaps market, as banks would be reluctant to make a price and then have to try to hedge that trade after its details are known to four rivals.
Bank to client trades are currently executed on single dealer platforms with an RFQ function on a single quote basis.
Even on Tradeweb’s electronic platform for swaps, RFQs are usually sent by a client to one or two dealers.
The bank director added: “The CFTC’s rules are overly prescriptive and taking the decision out of the hands of clients.”
Others have backed the CFTC’s rules, however, saying that increased transparency will encourage more participants and increase liquidity.
The CFTC, which has traditionally had oversight over futures markets, has had its reach expand sharply after Dodd-Frank, and now has oversight over most of the privately-traded swaps market. The SEC, however, has been given oversight over “securities-based swaps”.
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