SEC proposes rules for swap trading facilities

Institutional investors would get a chance to see the prices at which swaps are trading under a proposal put forth by U.S. securities regulators on Wednesday that is designed to shed light on the nearly $600 trillion swaps market.

The Securities and Exchange Commission's proposal would implement a major provision in the Dodd-Frank law that would move some swaps onto regulated trading platforms.

Customers would then be able to see if they are getting a good price from dealer banks such as JPMorgan and Goldman Sachs.

The swaps could be traded on a traditional exchange or a new facility created under Dodd-Frank known as a "swap execution facility," or SEF.

The SEC's rules would only apply to the narrow slice of the market it regulates under Dodd-Frank, which includes products like equity swaps and swaps used by investors who wish to hedge against a default on a single company's bonds.

The SEC agreed in a unanimous vote to put the rules out for public comment.

The SEC's proposal lays out a new regulatory scheme for SEFS, a burgeoning sector of the derivatives industry that is expected to generate fierce competition as numerous companies from IntercontinentalExchange to ICAP all plan to apply for SEF status.

The industry has urged the SEC and the Commodity Futures Trading Commission, which will have the lion's share of derivatives oversight, to be flexible in crafting their SEF rules.

They most fear the agencies will force SEFS to operate too much like traditional exchanges, a model they say doesn't work for many kinds of swaps because they are less frequently traded.

The SEC's proposal on Wednesday appears to take some of those concerns into account.

Under the plan, various kinds of trading platforms could qualify as a SEF. That means an exchange-like model with a "limit order book" that continuously updates bids and offers could qualify as a SEF, but that model isn't mandated.

Another model allowed under the plan that is likely to please the industry is the use of a "request for quote model" in which an investor submits a price request with the click of a mouse to several dealers.

The SEC said in a fact sheet this model could qualify as a SEF as long as certain requirements are met.

The trading system would not, for instance, be allowed to limit the number of dealers or liquidity providers to whom an investor can send a quote request.

However, an investor would also not be forced to send the request to every liquidity provider who is a member of the trading system.

That flexibility addresses industry concerns that too much transparency might harm the market and make it harder for traders to execute large, illiquid orders.

Similar to the CFTC's SEF proposal, which was put out for comment in December, the SEC's would also require SEFS to make firm and indicative quotes available to its users. Indicative quotes are the price a trader is willing to pay.

However, unlike the CFTC proposal, the security-based SEF would have to create and distribute "composite indicative quotes" for all swaps that trade on the SEF to all participants.

The SEC's proposal on Wednesday also lays out other various regulatory requirements for SEFs, including registration rules.

[Source: By Sarah N. Lynch, Reuters, Washington, 02Feb11]

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