Swap Execution Facilities and Organised Trading Facilities

A New Market Structure Emerges
by David Easthope, November 30, 2011
Industry Trends
EMEA, North America

Abstract

Trade execution on swap execution facilities (SEFs) and organised trading facilities (OTFs) is the future state of a massive reorganization of the swaps market structure based on the Dodd-Frank Act and MiFID II/MiFIR. Much is still theoretical, but we are moving closer to that reality. The future state can be reached by several divergent paths, but one path stands out.

In a new report, Swap Execution Facilities and Organised Trading Facilities: A New Market Structure Emerges, Celent offers key insights into the likely future direction of SEF/OTF markets and critical factors setting this direction. Based on these insights, Celent believes that there are multiple scenarios for the market structure to reach the SEF/OTF future state. However, because of fragile liquidity, industry feedback, and cautious regulators, a dominant scenario emerges as the most likely outcome.

For dealers and users, 2012 is likely to be choppy in and around SEF/OTF markets as participants try to get more comfortable with the idea of greater transparency and electronic execution on SEFs/OTFs. For operators, firms must come to grips with the notion that SEF/OTF status is a rite of passage, not a guarantee of success. Some SEFs/OTFs will attract liquidity; others will not. Furthermore, liquidity in the broader swaps market will ultimately be determined by how final regulatory rules are written, interpreted, implemented, and enforced.

“Overall, while we do believe that SEFs/OTFs will make the swaps market more electronic, transparent, and competitive, not all transparency is equal.” says David Easthope, Research Director with Celent’s Capital Markets Group and author of the report. “We especially believe price discovery could be hindered unless careful consideration is taken to make the rules adaptable and to reflect the fact that the swaps market is less liquid than some people imagine.”

Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is a wholly-owned operating unit of Marsh & McLennan Companies [NYSE: MMC].

Media Contacts

North America
Michele Pace
mpace@celent.com
Tel: +1 212 345 1366

Europe (London)
Chris Williams
cwilliams@celent.com
Tel: +44 (0)782 448 3336

Asia (Tokyo)
Yumi Nagaoka
ynagaoka@celent.com
Tel.: +81 3 3500 3023

Table of Contents

Executive Summary

3

Introduction

5

 

New Acronyms

5

 

Intentions and Realities

5

Dodd-Frank and MiFID II/MiFIR: Effect on the Swaps Market

6

 

Overview of the Dodd-Frank Act

6

 

Overview of EMIR

7

 

MiFID II/MiFIR

8

A New Market Structure to Evolve

10

 

Timing the US and Europe

11

A Comparison of SEF and OTF Rules and Practices

13

 

Product Coverage

13

 

Execution Venues

14

 

Execution Methodology

15

 

Governance and Membership

16

Prediction: Existing Execution Mechanisms Will Become the Primary SEFs/OTFs

18

 

Expected Developments in Market Structure

18

The Marathon Scenario: Market Structure Impact

20

 

Market Characteristics

20

 

Market Impact

21

Critical Factors in the Evolution of the Market Structure

23

 

An Unwelcome Scenario Where Nobody Wins

23

 

Getting Price Discovery Right

23

 

Getting the Trade Lifecycle Right

26

 

Getting Profitability Right

27

Players in the SEF/OTF Markets

28

 

The Two-Tier Market

28

 

Potential for Many Different SEFs/OTFs by Asset Class

29

To Build or Not to Build?

30

 

Considerations for Potential Market Operators

30

 

Considerations for IT Vendors

31

Conclusions

32

 

For Users and Dealers

32

 

For SEF/OTF Operators

32

 

For Regulators

32

Leveraging Celent’s Expertise

33

 

Support for Financial Institutions

33

 

Support for Vendors

33

Related Celent Research

34

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