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Swap-Trade Platforms Spurred by Dodd-Frank Weighed at CBOE, NYSE

CBOE Holdings Inc. and NYSE Euronext may create venues for derivatives that now trade over the counter to capitalize on proposed rules designed to bring more transparency to the $583 trillion market.

The exchange operators may form swap-trading platforms for privately negotiated derivatives that the government plans to move onto regulated trading systems or exchanges that will provide public data about prices and transactions, according to interviews with company executives over the last week. Most of the contracts are now traded between broker-dealers over the phone or through private electronic systems.

Congress last year ordered that most standardized OTC derivatives in the U.S. be guaranteed by clearinghouses and traded on exchanges or swap-execution facilities, also known as SEFs, after a 100-fold surge in trading of credit-default contracts over seven years made oversight of the financial system more difficult. Regulators are now writing rules for the swap platforms and the products that will be traded on them.

“Exchanges will be creating SEFs” and “we will explore creating our own” once the regulations are completed, CBOE Executive Vice Chairman Edward Tilly said in an interview last week at the Futures Industry Association conference in Boca Raton, Florida.

NYSE Euronext executives are discussing whether to start a SEF, said Walt Lukken, chief executive officer of New York Portfolio Clearing, a joint venture between NYSE and Depository Trust & Clearing Corp.


Derivatives sent to clearinghouses, the member-funded organizations that guarantee transactions and monitor collateral, must trade on SEFs or exchanges, according to the Dodd-Frank Act approved last year. SEFs that handle interest-rate and some credit-related swaps will be overseen by the Commodity Futures Trading Commission, while security-based SEFs, including credit default swaps on individual companies, will be under the Securities and Exchange Commission.

The global market for such transactions was $583 trillion as of June, according to the Basel-based Bank for International Settlements.

Banks and interdealer brokers that trade derivatives are the likeliest candidates to form SEFs since they’re in that business now, said Richard Repetto, an analyst at Sandler O’Neill & Partners LP in New York. The platforms could generate between $5 billion and $6 billion in annual revenue by 2013, according to a Feb. 16 joint report by Oliver Wyman consultants and Morgan Stanley analysts. Oliver Wyman is a unit of Marsh & McLennan Cos., the second-biggest insurance broker.

ICAP, Tullett

Interdealer brokers including ICAP Plc and Tullett Prebon Plc, both based in London, already have platforms to trade OTC products electronically or through a combination of voice brokers and electronic conduits. Tradeweb LLC, the bond and derivatives trading network partly owned by Wall Street’s biggest banks, intends to register as a SEF. GFI Group Inc. introduced RatesMatch, its electronic platform for interest rate swaps, on March 1. BGC Partners Inc. said it expects to qualify as a SEF. Tradeweb, GFI and BGC are in New York.

Banks often use the inter-dealer swaps market to lay off the risk of a transaction they have done with a customer, turning to brokers to enter the opposite trade with another bank. As OTC derivatives trading moves onto SEFs, the operators of those platforms will decide where to clear transactions, with clearinghouses competing for that business, Repetto said.


Clearinghouses are designed to reduce the effect of defaults by guaranteeing payments on securities, futures and derivatives, whose value is tied to an underlying asset such as interest payments, currencies or indexes. They collect collateral on open trades to keep accounts current and enable regulators to monitor prices and positions, reducing systemic risk.

CME Group Inc., IntercontinentalExchange Inc., Eurex and other exchange operators that trade futures or facilitate over-the-counter transactions are expanding their clearinghouse operations as banks and dealers prepare for regulatory reform of the derivatives market. Singapore Exchange Ltd. and the Mexican Derivatives Exchange, owned by Bolsa Mexicana de Valores SAB, also plan to clear more interest rate swaps, especially from domestic or regional dealers.

“Most exchanges are reluctant to talk about any SEF strategy in fear of antagonizing dealers -- not that they won’t get into it later,” Repetto said. “Right now, they’re focused on opportunities in clearing.”


ICE, based in Atlanta, intends to offer a SEF for credit-based products that are already being traded through its Creditex interdealer broker. It plans to register Creditex, its interdealer broker, as a SEF, Scott Hill, ICE’s chief financial officer, said in an e-mail. Creditex provides voice broking and electronic trading services for credit default swaps and credit index products. Hill said about half its volume globally takes place electronically.

The CME, which is expanding its clearing operation to attract interest rate and other off-exchange derivatives volume, hasn’t decided whether to provide a SEF to trade over-the-counter products, according to Bryan Durkin, chief operating officer at the Chicago-based company.

“CME’s plans to build a SEF haven’t been determined because the definition of a SEF hasn’t been formulated,” he said. “We’re very happy to provide our clearing solutions for eligible SEFs to hook up to us and bring their OTC business into our clearing organization.”

First Phase

Exchanges with clearinghouses aren’t as likely to be in the “first phase” of SEF creations, though they may get in later, according to Diego Perfumo, an analyst at Equity Research Desk in Greenwich, Connecticut.

“It’s a conflicting issue for exchanges that have clearing businesses,” he said. “They’ll be asking for a bank’s clearing business and will be competing on the execution side with them. Brokers will lose a lot of their role today, so they’ll fight fiercely over that.”

Gary Katz, chief executive officer of International Securities Exchange, said his market is studying the rules being written for SEFs. ISE has no “active project” to form a venue for OTC derivatives, he said. The options exchange is owned by Eurex, which is controlled by Frankfurt-based Deutsche Boerse AG and SIX Swiss Exchange Ltd. of Zurich. Deutsche Boerse agreed last month to buy NYSE Euronext for $9.53 billion.

Silvia Davi, a Nasdaq OMX Group Inc. spokeswoman, declined to comment about the exchange operator’s plans. New York-based Nasdaq OMX has a majority stake in the International Derivatives Clearing Group LLC, which clears interest rate swaps.

Bloomberg LP, the parent company of Bloomberg News, plans to register SEFs with the CFTC and with the SEC, according to a statement on March 17.

CBOE’s Tilly said he doesn’t know whether his company, if it decides to form a SEF once regulators complete their rules, would need to build one or two for products overseen by different agencies.

“It depends on how wide the gap is” between the SEC’s and CFTC’s requirements, he said.

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