Becoming a SEF – Regulation-driven cost or competitive opportunity?

July 22, 2011

A remarkable number of global financial institutions are actively pursuing setting up Swap Execution Facilities (SEFs) since they have become enshrined in U.S. law under the Dodd-Frank act. Recent announcements have delayed when they formally need to be ready, but few institutions care. Why?

Because SEF creation is the natural extension of better customer service. The better price discovery and deeper markets offered for OTC derivatives traded on SEFs will enrich what firms offer to their customers. This will drive business and profitability.

The OTC derivatives landscape has seen much change with the evolution of technology. Electronification has improved transparency and efficiency on many trading venues, enabling better executions on tighter spreads for all investors. Regulation is only pushing the natural evolution of business practice. Whatever the asset class, electronification has an impact on price discovery, liquidity consolidation and rapid execution. Technically, it is as easy to access a multi-participant interbank swaps market electronically as it is to access a multi-participant equity derivative market on an exchange.

Now, in this world where technology is a necessity, intermediaries need to offer one-stop electronic access to their services to be at the cutting edge. Bringing together the deepest liquidity across the widest range of financial products helps attract more business.

Today, increasingly sophisticated clients demand:

  • Excellent insight into their current position and the best tools to assess how they can maximize risk weighted returns
  • Near instantaneous best execution capabilities on consolidated liquidity across all markets – exchange and OTC derivative
  • Immediate real-time control of new positions, along with advanced risk management and monitoring tools
  • The potential, if requested, to have these positions “given up” to other institutions so credit risk can be balanced
To be profitable today and capitalize on change, not only do intermediaries need automation and a close eye on real-time risk, they need tight limit, compliance, collateral and operations capabilities. But most of all they need happy clients experiencing great service. Automated SEFs are a natural way of adding up new sources of liquidity enriching client service. Profitability tomorrow is the driver that is pushing SEF adoption – not regulation.

A final thought: with everyone taking the same approach, to stay ahead of the pack requires more. An ideal intermediary SEF strategy should not only rebrand or outsource internalization across all asset classes, but also offer a step change in end-customer experience. Intermediaries offering more, such as white-labelled market makers’ tools or cross SEF aggregation, will differentiate.

While you’re here…