What Is a Swap Execution Facility (SEF)?
A Swap Execution Facility (SEF) is an electronic platform provided by a corporate entity that allows participants to buy and sell swaps in a regulated and transparent manner.
- Swap execution facilities (SEFs) are trading platforms intended for swaps products.
- Because of the complex nature of swaps, these platforms are not exchanges but they do function as a counterparty matching service.
- Swaps volume has increased over the years and now dozens of entities provide SEF platforms.
Understanding Swap Execution Facility (SEF)
A SEF is an electronic platform that matches counterparties in a swaps transaction. Through a mandate in the Dodd-Frank Wall Street Reform and Consumer Protection Act, SEFs changed the methods previously used to trade derivatives.
The Dodd-Frank Act defined a SEF as, "A facility, trading system or platform in which multiple participants have the ability to 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."
Before Dodd-Frank, swaps were traded exclusively in over-the-counter (OTC) markets with little transparency or oversight. The SEF allows for transparency and provides a complete record and audit trail of trades.
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, OTC 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 reduces 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 Swap Execution Facility (SEF)
Many entities may apply to become a SEF. 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 (RFQ) system. In addition, 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.