More on the SEC-CFTC flash crash recommendations. In short, they’ll force platforms that do not publicly display price quotes to execute orders better than the midpoint, or otherwise route them out. This would kill the business model for many registered ATS’s. The goal of greater transparency is good – but the unintended consequences are huge. To me sounds like trying to fix something that isn’t broken, but many disagree.
Heavy-handed enforcement of rules that challenge business models could prove counter-productive, adds Kevin McPartland, senior analyst at research firm TABB Group. “They motivate firms to change their behaviour rather than out-right banning practices,” he said. “The more that they ban, the more it will force the market to work out ways to run strategies or manage risk in a way that would mimic what they were doing before.”
The CFTC and the SEC somehow found time in the midst of writing derivatives reform regulation to make recommendations on how to prevent another flash crash. I don’t think anything in here was too surprising, although I do think that they’re banning too many things rather than creating rules that incent a change in behavior.
Kevin McPartland, a senior analyst with capital markets advisory firm TABB Group, has some concerns about the panel’s approach.
“They want to ban a lot of practices. If they ban a practice, the market will likely find another way to do what they need to do. It would make much more sense to try to create a market structure that incents certain behavior,” he says.
I’ve spent the better part of the last year studying what will become the swap execution facility (SEF) market, how it will be regulated, its players, its impact on derivatives trading. More recently I’ve had the pleasure of speaking with a number of the industry’s leaders in the space regarding the plans for their organizations and how they believe the final rules should look once passed by the SEC and the CFTC.
I thought it was worth a post to create a single view of these conversations and provide a resource to anyone else looking to understand the new SEF landscape. So (in no particular order) here they are:
There are several more firms and individuals out there that play an important part in the SEF debate, and I hope to have similar “on-air” conversations with each. Until then, enjoy.
The SEC is set to release its SEF rules tomorrow, Feb 2, 2011, and only a small few details are floating around. Since they will be overseeing the less liquid single name CDS market I’d suspect they’ll focus more on the RFQ model than order book trading. My comments in the article, saying essentially, we don’t know yet:
“Apparently this is quite a mystery even to those in the industry very close to the situation,” said Kevin McPartland, a senior analyst with the TABB Group and an expert on SEF regulation.
Wall Street (which includes yours truly) was in Washington on Wednesday (Aug 15) to discuss Swap Execution Facilities with the Securities and Exchange Commission and the Commodity Futures Trading Commission.
I wasn’t the only one walking the block between Union Station, where the express train from New York arrives, to the SEC’s building. Walking in, my first thought was how can regulators complain about Goldman’s new building when theirs was just as new and (nearly) as shiny?
Esthetics aside, two panels focused on defining what a swap execution facility should be. The SEC sat on the left side of the U-shaped table and the CFTC on the right, with the panelists in the middle. The expected firms were present – independent platforms (MarketAxess, Tradeweb, Bloomberg), interdealer brokers (the Wholesale Markets Brokers Association, represented by Tradition), the futures exchanges (Chicago Mercantile Exchange and IntercontinentalExchange) and end users (PIMCO, et. al.).
There were some surprises. The Chicago Board Options Exchange was there. It took me a few minutes to figure out why, but their FLEX platform for trading bespoke equity options contracts could easily become an SEF. NASDAQ participated as well. Their motives are less clear. The only obvious link is their partial ownership of fledgling interest rate swap clearing house IDCG.
SEC Chairman Mary Shapiro sat in the front row as did CFTC Chairman Gary Gensler. Neither asked questions of the panelists directly, although Mr. Gensler couldn’t help but whisper into the ears of his staffers during the proceedings. The audience was a mix of dealers, IDBs, press and a high frequency trading firm or two. The SEC could have made things much more interesting by issuing visitor badges listing company names in addition to panelists’ names.
I learned a few things, though the arguments for and against each open issue were mostly restatements of ideas already aired. I will dig into these and other open issues in an upcoming research report, so stay tuned. The questions from the regulators – dominated by the CFTC – were thoughtful and focused in the right places; a stark difference from the early days of Congressional meetings in which one was often left wondering how well members of the legislature understood what a swap was.
Just over 300 days remain until these rules must be in place per Dodd-Frank. It is now abundantly clear that the OTC derivative execution landscape is going to change. Exactly what it will look like is still a good topic for debate (and a topic I will discuss in forthcoming research) but in this analyst’s opinion, we’re moving in the right direction.
I don’t have enough information to make an accurate call on the issues between the SEC and Goldman Sachs, but it appears from this ABC News article that my broad thoughts on the issue are pretty common all around lower Manhattan. There needs to be two sides to every trade:
Kevin McPartland, senior analyst at TABB Group, a New York-based financial services research and advisory firm, said he didn’t learn much new in the hearings.
“Congress and Wall Street don’t see eye to eye,” he said. “Institutional traders are smart, well-informed people, yet someone is on each side of every trade with an opposing view. If not then we wouldn’t have capital markets.”
US News has done a good job of covering the Goldman Sachs/SEC lawsuit. My comments stay away from passing any judgement in either direction:
“In some ways, this is Wall Street 101 in that there needs to be somebody on both sides of every deal. So clearly you have a world full of smart financial firms, but still with those firms often taking bets opposite of each other,” says Kevin McPartland, a senior analyst with the TABB Group, a financial-sector research and advisory firm. “There’s always going to be somebody that’s looking in the opposite direction.”