Sef execution agreement requirement angers buy side

Buy-side firms complain about the documentation burden ahead of the October 2 Sef deadline

Buy-side firms are refusing to sign participation agreements with some newly registered US swap execution facilities (Sefs), because of a controversial requirement that commits end-users to negotiate bilateral trade breakage agreements with any counterparty they transact with on the trading venues, Risk has learned.

New Sefs, including New York-based TW Sef – an affiliate of Tradeweb Markets – and at least one interdealer broker, are stipulating that end-users have execution agreements in place, which set out breakage terms and termination payments with counterparties in the event a trade is rejected by a clearing house.

Firms that don't meet this requirement may not be able to trade on those platforms after October 2, when the new Sef regime comes into force.

Some participants have reacted angrily to the clauses, claiming it is not possible to negotiate execution agreements with large numbers of counterparties before the October 2 start-date – meaning buy-side firms will essentially be forced to transact with a handful of large dealers.

"Euphemistically, the Sefs are calling this process enablement, as in ‘sign this agreement and you will be enabled to trade on our platform'. In reality, the process should be termed constraint," says one buy-side trader.

"There is a long history of dealers trying to use bilateral counterparty credit risk as a wedge to keep the dealer-only paradigm in place. These agreements mean you can only trade on that Sef with counterparties you have execution agreements with, and, as a practical matter, you're not going to negotiate these documents with all 100 participants on a Sef – you're only going to do so with the large swap dealers," he adds.

Buy-side firms have spent recent weeks examining the rulebooks published by the 17 trading platforms that have applied to the US Commodity Futures Trading Commission for temporary registration as Sefs. So far, 12 of the applicant venues – 360 Trading Networks, BGC Partners, Bloomberg, GFI Group, Ice Swap Trade, Javelin Capital Markets, MarketAxess, State Street's SwapEx, TeraExchange, Tradeweb's DW Sef and TW Sef and TrueEx – have received provisional approval.

The burden of working through these rule books ahead of October 2 deadline is proving a significant task in itself for buy-side firms, which complain the addition of restrictive execution agreements is compounding their documentation workload.

"The issue from our perspective is the volume of documents we need to now sign. While we are expecting to have signed agreements in place by the deadline, going through these rule books and working through agreements to be able to continue to trade products electronically is very frustrating. Some Sefs are requiring execution agreements and some are not, but absent a clearing mandate – and many of the trades we are clearing now aren't subject to a clearing mandate – it is not clear to me why I would need a cleared derivative execution agreement, because if the trade breaks I'll simply make it a bilateral trade," says Michael O'Brien, head of global trading at Eaton Vance in New York.

The necessity of execution agreement, formally termed a cleared derivatives execution agreement and developed jointly by the Futures Industry Association (FIA) and International Swaps and Derivatives Association, has also divided the Sef community. Some venues insist they are an important safeguard that provides legal certainty in the event of a trade rejection.

"These execution agreements are not stopping any participant from coming onto TW Sef to make markets to clients. In the event a trade does not clear, we need to have a fall-back position we can take to deal with any trades that may be rejected from clearing – which counterparty owns the trade in that situation? You need to have a process by which that eventuality is dealt with, and that's why we need to have these agreements in place," says Lee Olesky, chief executive of Tradeweb Markets in New York.

However, others have a different view, arguing the agreements are unnecessary on Sef platforms.

"We don't accept the Isda-FIA agreements. These agreements say that if we send a trade for clearing and it fails, I can sue the original counterparty for the loss. The problem is, if your futures commission merchant is shutting you out of clearing, it's not because you don't have the money to pay for the trade today, it's because you're perceived to be a straw man that is going to be bankrupt tomorrow. All one of these agreements gives me is the right to sue an insolvent counterparty and to incur millions in legal costs in order to recover pennies on the dollar years from now. And these agreements have not even been tested. Why would a Sef want to get involved in these sorts of disputes?" he says.