DerivAlert Blog

The Need for Swap Execution Facilities

The pending financial regulatory changes currently being debated in Congress could create the mandate that all OTC derivatives trades be executed via a swap execution facility (SEF) or exchange. If that particular requirement passes to the final version of the bill, which is expected to be finished as early as July 4, SEFs will become a necessary part to creating an efficient and effective OTC derivatives marketplace.

The creation of swap execution facilities would serve to promote electronic trading in OTC derivatives markets. While most swaps are currently traded via phone, electronic trading is already on the rise as market participants take advantage of the benefits of electronic trading, such as greater efficiency and transparency. The proliferation of SEFs in the derivatives market would create healthy competition among execution venues - just like ECNs or ATSs did for the equities trading space. Leaving electronic swap execution just to exchanges would miss the mark as there is a limited pool of institutional buyers and sellers of OTC derivatives, making the market unsuitable for "exchange" trading. Because of the large sizes of trades and the bespoke nature of the market, it is also important that the role of liquidity provider is preserved, which is most easily done through a "request-for-quote" style market.