What is a 'Swap Execution Facility - SEF'

A Swap Execution Facility (SEF) is a platform that allows participants to buy and sell swaps in a regulated and transparent manner. Through a mandate in the Dodd-Frank Wall Street Reform and Consumer Protection Act, SEFs change the methods previously used to trade derivatives.

BREAKING DOWN 'Swap Execution Facility - SEF'

The Dodd-Frank Act defines a swap execution facility (SEF). "A facility, trading system or platform in which multiple participants (can) execute or trade swaps by accepting bids and offers made by other participants that are open to multiple participants in the facility or system, through any means of interstate commerce." In short, there are now several approved platforms under the SEF umbrella which allow for multiple bids and offers.

Before Dodd-Frank, the trading of swaps was traded exclusively in over-the-counter markets with little transparency or oversight. As a result, the expected role of the swap execution facility allows for transparency and provides a complete record and audit trail of trades.

The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) regulate SEFs. Regulatory changes now require clearing, settlement, and reporting functions. Requirements are also in place in Europe, but the oversight is fragmented.

An Exchange for Swaps

A SEF is similar to a formal exchange but is a distributed group of approved trading systems. The handling of trades is similar to other exchanges. Also, the Dodd-Frank Act states if no SEF system is available for specific swaps, then the previous, over-the-counter trading method, is acceptable.

Proponents argue that a SEF is a swaps exchange, much like a stock or futures exchange, and they are correct, to a degree. Centralized clearing of swaps and other derivatives reduce counterparty risks and increases trust and integrity in the marketplace. Also, a facility that allows for multiple bids and offers provides liquidity to the swap marketplace. This liquidity enables traders to close positions ahead of contract maturity.

Becoming a SEF

Many entities may apply to become a swap execution facility. To qualify, they must meet specific thresholds as defined by the SEC, CFTC, and the Dodd-Frank Act. Applicants must register with the SEC and meet specific requirements. Requirements include the platform's ability to display all available bids and offers, send trade acknowledgments to all involved parties, maintain a record of transactions, and provide a request for quote system. Further, they must meet certain margin and capital guidelines and the ability to segregate the swap exchange. Finally, the applicant must agree to abide by the 14 SEC core principles.

RELATED TERMS
  1. Forward Swap

    A forward swap is an agreement between two parties to exchange ...
  2. Swap Curve

    A swap curve identifies the relationship between swap rates at ...
  3. Reverse Swap

    A reverse swap is an exchange of cash flow streams that undoes ...
  4. Amortizing Swap

    An amortizing swap is an exchange of cash flows, one fixed rate ...
  5. Swap

    A swap is a derivative contract through which two parties exchange ...
  6. Cross-Currency Swap

    An agreement between two parties to exchange interest payments ...
Related Articles
  1. Trading

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  2. Trading

    Currency Swap Basics

    Find out what makes currency swaps unique and slightly more complicated than other types of swaps.
  3. Trading

    Different Types of Swaps

    Identify and explore the most common types of swap contracts. Swaps are derivative instruments that represent an agreement between two parties to exchange a series of cash flows over a specific ...
  4. Investing

    The Advantages Of Bond Swapping

    This technique can add diversity to your portfolio and lower your taxes. Find out how.
  5. Investing

    The Fast-Paced World of Libor & Fixed Income Arbitrage

    LIBOR is an essential part of implementing the swap spread arbitrage strategy for fixed income arbitrage. Here is a step-by-step explanation of how it works.
  6. Trading

    Hedging with currency swaps

    The wrong currency movement can crush positive portfolio returns. Find out how to hedge against it with currency swaps.
  7. Trading

    Derivatives 101

    Learn how to use derivatives to hedge, speculate or increase leverage in an investment portfolio.
  8. Investing

    SPXU: ProShares UltraPro Short S&P500 ETF

    Find out information about the ProShares UltraPro Short S&P 500 exchange-traded fund, and learn detailed analysis of its characteristics and suitability.
  9. Personal Finance

    The Bloomberg Terminal At A Glance

    The Bloomberg Terminal is one of the most popular tools for real-time financial information. Find out what it is and what it can do for you.
  10. Taxes

    10 Things to Know About 1031 Exchanges

    Real estate swaps grow popular, but traps are many. Here's 10 things to know when considering 1031 swaps. Also: Beware new rules on vacation homes.
RELATED FAQS
  1. When was the first swap agreement and why were swaps created?

    Learn about the history of swap agreements, the first swap agreement between IBM and the World Bank, and how swaps have evolved ... Read Answer >>
  2. What is the difference between derivatives and swaps?

    Swaps comprise just one type of the broader asset class called derivatives. Read Answer >>
  3. What is a Debt for Equity Swap?

    Learn why companies issue debt for equity swaps, what they are, and how they impact shareholders and debt holders. Read Answer >>
  4. How does an entrepreneur choose a business structure?

    Learn more about interest rate swaps and currency swaps, how these swaps are used and the difference between interest rate ... Read Answer >>
  5. What is the difference between the Sarbanes-Oxley Act and the Dodd-Frank Act?

    Learn about the differences between the Sarbanes-Oxley Act and the Dodd-Frank Act, and understand the reasons why each bill ... Read Answer >>
  6. What is the difference between derivatives and options?

    A derivative is a financial contract that gets its value from an underlying asset. Options offer one type of common derivative. Read Answer >>
Trading Center