SOURCE: Derivatives Special Report

COVER STORY
■ Scott O’Malia, chief executive of the
International Swaps and Derivatives Association
When swap execution facilities (SEF)
were launched in the US last year
there were high hopes that electronic
trading would fast become the preferred means
of transacting OTC swaps. A year on, however,
there is evidence of disappointing take-up
in electronic trading and growing concerns
about geographical fragmentation, raising key
questions over the current evolution of the
swaps market.
Swaps data continues to indicate a reluctance
to trade electronically through SEFs as
well as increasing regional fragmentation. The
latter trend has been especially pronounced for
euro interest rate swaps since SEFs went live
in the US, with European dealers increasingly
opting to trade with other European parties
rather than US firms.
Along with the issue of geographical fragmentation
and a continued preference by many
market participants to engage in voice trading
methods, SEFs are also having to contend with
the reluctance of many buy-side firms to sign
up with them directly. Against this backdrop,
there are increasing expectations that there will
soon be a round of consolidation within the
SEF market as underwhelming volumes mean
that many of the 20 registered venues are
already struggling to make a profit.
Swap challenge
In the aftermath of the financial crisis,
G-20 leaders pointed to the limited pricing
20
transparency, high leverage, and opaque risks
attached to the OTC derivatives market, and
agreed to make legislative changes in order to
reshape the market. The subsequent legislation
that followed, in the form of the Dodd Frank
Wall Street Reform and Consumer Protection
Act (Dodd-Frank) and the European Market
Infrastructure Regulation (EMIR) rules, sought
to reduce systematic risk largely through increased
transparency and oversight. Common
to both the European and US acts was the
emphasis on increased standardisation, central
clearing, higher standards of conduct and the
use of electronic trading platforms.
owever, many buy and sell-side firms alike
argue that maintaining a truly global OTC
derivatives market is key to ensuring sufficient
liquidity, and the generally more stable trading
environment that comes with having a diverse
range of potential counterparties. A wider
range of participants should theoretically allow
trades to be transacted at the lowest possible
cost, thereby boosting market efficiency.
Data from L.C.H Clearnet SwapClear certainly
points to increased fragmentation across
the global Swaps market since SEFs went live
in the US in early October last year.
In short, there has been a dramatic change
in behaviour as European dealers have become
increasingly reluctant to trade with US counterparties.
On some measures, the amount of
business being transacted between US and
European traders has fallen by around 70%.
Cross-border harmonisation
is a big concern. Without
it, markets will fragment,
splitting liquidity pools
along geographic lines and
increasing costs for
end-users
For instance, prior to October 2013, there
were well over €650 billion in euro interest rate
swaps (IRS) a month being transacted between
European and US dealers. Since October last
year, however, this business had significantly
fallen off with the level of transactions having
dipped below the €200 billion mark by May
this year.
Uncoordinated
Along with reducing market efficiency, some
even claim the current trend is actually increas-
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