Swap Execution Facility is a new entity created by Dodd-Frank Wall Street Reform and Consumer Protection Act (in US).
A swap is broadly defined to include most OTC derivatives. Rates swaps, currency swaps, equity swaps, credit default swaps and commodity swaps are all included in the definition.
This legislation mandates that all OTC derivatives trades be executed via a swap execution facility.
A ‘swap execution facility’ means a facility trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by other participants that are open to multiple participants in the facility or system.
Thus this swap execution facility would appear to be an exchange-like entity with pre-trade and post-trade information displayed to all participants and with the ability to actually execute trades with a view to ensure
- Increase transparency
- Improved market efficiency
- Prevention of market abuse
Thus the expected role of a SEF is to provide pre and post trade transparency, encourage competitive execution for the entire market place and provide the tools required to ensure a complete record and audit trail of trades. This market transparency and efficiency is expected to facilitate counter party risk management on a dynamic basis.
Minimum requirements of a Swap Execution Facility will include
- It must be a ‘many to many’ execution platform to permit multiple participants to trade by accepting bids and offers made by multiple participants
- It must permit and provide for impartial, timely accesses with netting, margining (including cross product margining) and clearing and settlement links
- It must establish and enforce rules to detect and deter trade abuses with a clear mandate to investigate to detect violations.
- It must permit and provide for trading in non-manipulated swaps
- It must ensure real time monitoring of trading and have systems to permit accurate and comprehensive trade reconstructions
- It must provide timely information (real time?) on prices and trading volumes to all
While there is some clarify on ‘what is a SEF’, ‘mode of execution’ and provision of ‘trade transparency’, issues like ‘self regulation’ and ‘conflicts of interest’ are to be debated in greater detail.
In a nut shell, an ideal functional model for Swap Execution Facility will include
- Participants
- Products
- Post Prices
- Market Making
- Order Matching
- Trading
- Block Trades
- Netting
- Margining
- Cross Product Margining
- Clearing
- Settlement
- Static Data Management
- Golden Copy
- Reports
The idea of a swap execution facility appears to be simply great in paper. It should turn out to be so in practice too!