On Friday afternoon Javelin SEF filed the first made available-to-trade application with the CFTC (thanks Jamie for making us all scramble around on a Friday afternoon!). This is great news. The ball is rolling that will make SEF trading volumes finally matter. But of course, as with everything derivatives reform, things are not yet cut and dry.
First the choice of product. The filing covers interest rate swaps in USD, GBP and EUR from one day to 51 years in duration. This is most of the rate curve, although it most definitely does not cover all interest rate products mandatory for clearing (FRAs and OIS, for example). Silla at Bloomberg News wrote up the filing on Friday afternoon including my plain English explanation as why this matters:
“These products are some of the most widely used in the swaps space,” Kevin McPartland, head of market structure and research at Greenwich Associates, said in a telephone interview yesterday. “Most institutions holding some form of debt use these products to manage interest-rate risk.”
Making the entire rate curve available for trading does force many illiquid issues to be traded via SEF. Off-the-run IRS and IRS with custom durations (often used by the aforementioned institutions to hedge rate risk) trade infrequently following their creation. This might lead some to believe that only the most liquid points on the curve (e.g. 2,5, 7, 10, 15, 30) or the standardized MAC contracts would have been a more reasonable place to start, but that would have only created more confusion. I think of the buy side trader doing a swap spread trade, left trying to figure out what has to be done on the SEF and what can be done on the phone. Yes, they are smart and capable, but why make this complicated shift even more confusing.
Then comes the timing question. The CFTC has decided to review for up to 90 days which includes the 30 day comment period (the latter of which started on Friday, so get commenting). At the end of the 90 days we expect a 30 day implementation period. This would put the date at February 15, 2014. But if the clearing implementation early in 2013 is any indication, the date will likely be a few weeks later. (If anyone has heard otherwise please let me know).
And while we’re comparing the implementation of trading and clearing mandates, we are hopeful that the phase-in approach used for clearing will be applied to trading as well. Dealers first, then the core of the buy side, then everyone else. Sorting out the interdealer markets will ensure dealers are ready to offload risk amongst themselves so as to provide clients the liquidity they need. And dealers are less concerned about making mistakes when trading with peers then they are trading with clients. It has been suggested that phasing in on-the-run contracts first could also be an option, but per my above comments I think this approach might cause more confusion than is necessary (remember on the run changes daily with IRS).
That all said, we still do not have a MAT application for CDS. I’ve argued in the past that on-the-run CDX.IG could be more suited for SEF trading than any other swap in question, given the standardization and high level of e-trading in the product today. Does anyone want to guess who will file the CDS MAT application first? I explained in recent Reuters article why many aren’t in a rush to file:
“The sooner a SEF applies for MAT the sooner everyone is forced to trade on platform, and very, very few actually want on-SEF trading to happen sooner rather than later,” said Kevin McPartland, principal at Greenwich Associates in the market structure division.
This is why it has been expected that a startup will file first (as was the case for IRS). But in the CDS space, the startups have been more focused on rates than on credit (although CDS trading on some of those platform is in fact offered) which makes the path forward for CDS MAT less certain. I suspect the market will wait and see how things go with this first application before making another one. Either way, hopefully the CDS MAT will be filed mid-morning on a quiet Tuesday.
From Javelin’s MAT application: