We want to respond to requests for clarity on the role of a swap execution facility, or “SEF.” Despite what some may be telling you, a SEF is not a futures exchange, called a designated contract market (“DCM”) under the U.S. Commodity Exchange Act (“”CEA”). Although both are organized markets regulated under the CEA and both have self-regulatory obligations over their market participants, there are important differences between a SEF and a futures exchange. So let us set the record straight (again).
- SEFs are a relatively new type of regulated organized market, added to the CEA in 2010, whereas futures exchanges have been around for many decades. The CFTC approved the first SEFs in 2013. The CEA contains separate and distinct statutory provisions governing SEFs and governing DCMs; likewise, the CFTC has different sets of rules that apply to SEFs and to DCMs.
- The requirements that apply to a SEF are tailored to the role that a SEF performs in the swaps markets. As we’ve explained before, certain types of interest rate and credit default swaps generally must be traded on a SEF, but for other types of swaps – which notably include energy and other commodity-based swaps – a market participant has a choice whether to trade over a SEF, and on which one, or through some other permissible means.
- In contrast, U.S. futures exchanges list futures and options on futures for trading, and may also list derivatives classified as swaps for trading, although that is far less common. All trades in a DCM’s contracts are subject to centralized clearing. If a person wants to trade a derivative that is a futures contract or an option on a futures contract, it may only do so on or subject to the rules of the exchange listing the contract. The contracts that DCMs list for trading tend to have highly standardized terms, as that is more conducive to the type of centralized auction markets they provide.
- SEFs and DCMs are both held to standards for providing open access to qualified market participants. When trading on a SEF, parties typically know the identities of their potential counterparties, whereas trading on a DCM’s centralized market typically occurs anonymously. For various reasons, DCMs generally attract a much broader base of market participants than SEFs. In particular, SEFs for swaps based on energy or other physical commodities have faced challenges attracting market participants in part because market participants are not required to use a SEF to enter into such transactions. Market participants may also find the cost structure, additional fees or contractual terms for accessing a particular SEF to be unattractive. In any case, those are factors along with others that market participants may evaluate when deciding where and how to execute a swap transaction.
These are but a few of the distinctions between a SEF and a DCM that we find significant; there are others.
At Mobius, we believe in market transparency and helping our clients evaluate their different hedging tools to meet their unique business needs. For example, in addition to option and swap structures many of our clients are now finding that managing market risk through pricing terms in their commercial (physical) agreements is a more effective transaction from a liquidity and credit perspective. Additionally, a number of financial institutions on the lending side are now giving credit for required hedging activity that has been executed through their commercial agreements.
Should you require additional information or have inquiries please contact:
Christine Anderson, Chief Operating Officer, email@example.com
Paul Smith, Chief Risk Officer, firstname.lastname@example.org
Phil Thompson, Vice President and Co- Head, Commodities Risk, email@example.com