March 15, 2019
Mr. Christopher J. Kirkpatrick
Secretary
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street NW
Washington, DC 20581
Re:

Proposed Rule on SEFs and the Trade Execution Requirement (RIN 3038–AE25)

We appreciate the opportunity to provide comments to the Commodity Futures Trading
Commission (the “Commission”) on its proposal to amend the regulatory framework for swap
execution facilities (the “SEF Proposal”).1
The existing SEF regime has resulted in a more open, competitive and transparent OTC
derivatives market, yielding material benefits for end investors in terms of pricing and liquidity,
while reducing risk and complexity for market participants. Although we agree that the existing
SEF regime can be further refined, the SEF Proposal significantly dismantles the current
framework, threatening to reverse the material benefits that have accrued to market participants
over the course of more than five years of SEF trading.
Our response focuses on three aspects of the SEF Proposal that are particularly consequential:I.

The SEF Proposal Abandons Multilateral and Transparent Execution, Harming
Investors
The SEF Proposal advances a novel interpretation of the statutory definition of a SEF to
include platforms that only offer bilateral trading protocols, such as single-dealer pages or
RFQ-to-1, undermining market transparency and competition. In addition, the SEF
Proposal completely eliminates minimum standards for multilateral and pre-tradetransparent execution on SEFs by allowing all transactions to be executed via private oneto-one negotiations that resemble bilateral over-the-counter trading.

II.

The SEF Proposal Endorses Anticompetitive Practices by SEFs
The SEF Proposal permits SEFs to engage in a variety of discriminatory practices bydramatically re-interpreting the statutory requirement for SEFs to provide market
participants with impartial access. Sanctioning discriminatory access criteria will
negatively impact market competition and liquidity, as new or smaller liquidity providers
may be blocked from accessing necessary liquidity pools and clients may be deprived ofany opportunity to access certain liquidity pools and trading protocols.

1

83 FR 61946 (Nov. 30, 2018), available at: https://www.cftc.gov/sites/default/files/2018-11/2018-24642a.pdf .
Page 1 of 42

III. The SEF Proposal Introduces Material Risks to the Clearing Workflow
The SEF Proposal fundamentally alters current execution-to-clearing operational
workflows for SEF trading by failing to preserve the current straight-through-processing(“STP”) standards. Cleared swaps executed on a SEF would no longer be required to besubmitted to a CCP within 10 minutes, introducing material market, credit, and operationalrisks. Further, bilateral breakage agreements between each pair of trading counterparties
would now be permitted for cleared swaps on SEFs, disrupting liquidity provision and
impeding access to SEFs.
In each of these three key areas, we will detail how:

The current regulatory framework has provided material benefits to investors;

The SEF Proposal will erode these documented benefits and impede market evolution;

The SEF Proposal is inconsistent with the Commodity Exchange Act (“CEA”);

The SEF Proposal conflicts with internationally-harmonized standards; andThe SEF Proposal fails to satisfy a cost-benefit analysis.

We urge the Commission to protect and strengthen the preeminent global position of U.S.
capital markets by supporting regulations that are designed to make markets more fair, open,
competitive, and transparent. While the current SEF Proposal would fail to do so, we believe there
are more targeted and pragmatic steps that can and should be taken. Therefore, for each key area
above, we also provide alternative policy suggestions that are designed to further streamline the
SEF regime in a manner that is consistent with the CEA and that would preserve, and build upon,
the documented benefits realized to date by market participants.
Our response to the SEF Proposal is informed by the market experience of two separate anddistinct units – Citadel Securities, a leading global market maker, and Citadel, a global investment
firm.
Citadel Securities is a leading global market maker across equities and fixed income asset
classes, and entered the U.S. interest rate swaps market as a new liquidity provider following theimplementation of the Commission’s SEF rules. Citadel Securities has become one of the top
liquidity providers in this market, increasing competition and improving conditions for end
investors by introducing innovations such as firm on-screen pricing. Citadel Securities wasrecognized as the “rates flow market-maker of the year” in both 2017 and 2018, 2 and is a
Commission-registered swap dealer and a self-clearing member.
Citadel is a leading investor in the world’s financial markets, including in OTC derivatives
markets regulated by the Commission. Citadel participates in these markets both on-SEF and offSEF, and has directly witnessed the material benefits for end investors that have resulted from theimplementation of the Commission’s SEF rules.
2

See https://www.risk.net/risk-magazine/analysis/2480595/rates-flow-market-maker-of-the-year-citadel-securities
and https://www.risk.net/awards/5362966/rates-flow-market-maker-of-the-year-citadel-securities.
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Table of Contents
I.

The SEF Proposal Abandons Multilateral and Transparent Execution, Harming Investors .................. 4
A. The Current Regulatory Framework Has Provided Material Benefits to Investors ............................ 4
B. The SEF Proposal Will Erode Documented Benefits and Impede Market Evolution ........................ 6
C. The SEF Proposal is Inconsistent with the Commodity Exchange Act .............................................. 7
D. The SEF Proposal Conflicts with Internationally-Harmonized Standards .......................................... 9
E. The SEF Proposal Fails to Satisfy a Cost-Benefit Analysis .............................................................. 10(i) Required Transactions: Costs and Benefits ................................................................................... 15(ii) Permitted Transactions: Costs and Benefits ................................................................................. 19(iii) Off-SEF MAT Transactions: Costs and Benefits........................................................................ 19(iv) Off-SEF Non-MAT Transactions: Costs and Benefits................................................................ 19(v) Conclusion: Costs and Benefits .................................................................................................... 21
F. Suggested Alternatives ...................................................................................................................... 22

II. The SEF Proposal Endorses Anticompetitive Practices by SEFs ......................................................... 24
A. The Current Regulatory Framework Has Provided Material Benefits to Investors .......................... 24
B. The SEF Proposal Will Erode Documented Benefits and Impede Market Evolution ...................... 25
C. The SEF Proposal is Inconsistent with the Commodity Exchange Act ............................................ 26
D. The SEF Proposal Conflicts with Internationally-Harmonized Standards ........................................ 28
E. The SEF Proposal Fails to Satisfy a Cost-Benefit Analysis .............................................................. 28
F. Suggested Alternatives ...................................................................................................................... 30
III. The SEF Proposal Introduces Material Risks to the Clearing Workflow ............................................. 31
A. The Current Regulatory Framework Has Provided Material Benefits to Investors .......................... 31
B. The SEF Proposal Will Erode Documented Benefits and Impede Market Evolution ...................... 33
C. The SEF Proposal is Inconsistent with the Commodity Exchange Act ............................................ 33
D. The SEF Proposal Conflicts with Internationally-Harmonized Standards ........................................ 34
E. The SEF Proposal Fails to Satisfy a Cost-Benefit Analysis .............................................................. 34
F. Suggested Alternatives ...................................................................................................................... 38
IV. Other Topics ......................................................................................................................................... 40
A. Scope of the Trade Execution Requirement ...................................................................................... 40
B. Pre-Execution Communications and Block Transactions ................................................................. 41
C. Improving SEF Disclosures .............................................................................................................. 41

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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

I.

The SEF Proposal Abandons Multilateral and Transparent Execution, Harming
Investors

The SEF Proposal fundamentally re-interprets the statutory definition of a SEF to include
platforms that only offer bilateral trading protocols, such as single-dealer pages or RFQ-to-1. In
addition, the SEF Proposal eliminates minimum standards for multilateral and pre-tradetransparent execution by allowing all SEF transactions to be executed via one-to-one private
negotiations. These proposals threaten to reverse the material benefits that have accrued to clients
under the current regulatory framework, including better liquidity, greater competition, and lower
transaction costs.
Below, we detail the benefits of the current regulatory framework and the expected adverse
impacts of the SEF Proposal. We then explain how these proposals are inconsistent with statutory
requirements in the CEA, conflict with internationally-harmonized standards, and fail to satisfy acost-benefit analysis. We also note that these proposals are inconsistent with the recommendations
made by the U.S. Department of the Treasury in its 2017 Capital Markets Report, which
specifically note the importance of maintaining multilateral and pre-trade transparent execution on
SEFs.3 Finally, we provide alternative suggestions that are designed to further streamline the SEF
regime in a manner that is consistent with the CEA, while preserving the documented benefits
realized by market participants.
A. The Current Regulatory Framework Has Provided Material Benefits to Investors
We leverage Citadel’s experience as an end investor in the swaps markets, both on-SEF and
off-SEF, to describe the material benefits for clients that have directly resulted from the market’stransition to multilateral and transparent execution under the current SEF regime.
Prior to the introduction of SEFs, dealer-to-client trading in interest rate swaps (“IRS”) andindex credit default swaps (“index CDS”) was opaque and fragmented, with most executions
arising out of one-to-one private negotiations. Although electronic trading platforms existed, suchas Bloomberg and Tradeweb, adoption rates were low and liquidity providers instead focused on
bilateral means of communication with clients, such as single-dealer pages and “dealer runs.”4
When engaging with clients, liquidity providers would typically provide “indicative” quotes (asopposed to firm binding quotes), inviting interested clients to follow-up bilaterally in order toobtain an executable price for a specific instrument.
From a client’s perspective, this market structure was disadvantageous for several reasons.
The lack of published firm quotes and the unavailability of multilateral trading protocols
compelled clients to rely on one-to-one private negotiations in order to obtain an executable price.
Given that these executable prices were only then honored at that exact moment in time, clients3

See A Financial System that Creates Economic Opportunities: Capital Markets (October 2017) at page 145,
available at: https://www.treasury.gov/press-center/press-releases/documents/a-financial-system-capital-marketsfinal-final.pdf.
“Dealer runs” were lists of specific instruments that liquidity providers were interested in trading, along withindicative prices.
4

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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

were unable to effectively put liquidity providers in competition and had little to no pre-tradetransparency regarding other available prices in the market. Instead, clients faced the choice ofeither accepting the first executable price received or starting over with a new one-to-one
negotiation, where pricing could move against the client as its trading interest was sequentiallydisclosed to additional market participants. As a result, this opaque and fragmented execution
process impaired client access to best execution by denying clients the ability to effectively
compare and evaluate the quality of prices.
In contrast, from the perspective of an incumbent liquidity provider, the pre-SEF trading
environment was extremely beneficial. By providing only an indicative quote, a liquidity provider
could solicit trading interest from clients, leading them to reveal their trading interest before
responding with an executable price. The lack of published firm quotes and the inability toeffectively put liquidity providers in competition also facilitated “tiered” pricing based on theidentity of the client, enabling liquidity providers to extract greater profits from smaller market
participants.
The statutory requirements in the CEA relating to SEFs, and the Commission’s SEF rules,
dramatically altered the dealer-to-client trading environment for IRS and index CDS bytransitioning trading activity to multilateral and pre-trade transparent platforms. Two aspects ofthe current regulatory framework were central in this regard:Ensuring SEFs are Multilateral. SEFs are platforms that offer multilateral trading
protocols, instead of only single-dealer pages or one-to-one negotiations; andEnforcing Minimum Standards for Multilateral and Pre-Trade Transparent Execution.
Instruments subject to the trade execution requirement, which constitute a core segmentof the IRS and index CDS market, are required to be transacted via multilateral and pretrade transparent trading protocols, such as multilateral RFQs (i.e. RFQ-to-3).

Since SEFs are required to be multilateral, the market transitioned away from bilateralnegotiations and single-dealer pages to platforms where quotes from multiple liquidity providers
could be more easily consolidated and compared. At the same time, since a core segment of the
IRS and index CDS market is required to be transacted via multilateral and pre-trade transparent
trading protocols, the market transitioned away from a sole reliance on one-to-one private
negotiations. Instead, liquidity providers suddenly had no choice but to compete with each otherto win many client transactions.
This market evolution delivered material benefits for clients. The resulting competition andtransparency has improved liquidity conditions, reduced transaction costs, and facilitatedexecution quality analysis. Clients have been empowered to put liquidity providers in direction
competition. On-screen pricing has materially improved, becoming more competitive anddependable, as liquidity providers seek to differentiate their offerings in light of the increased
competition. This trend has particularly benefited smaller market participants, as widely available
on-screen pricing makes it more difficult for liquidity providers to discriminate against certain“tiers” of clients.

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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

While the above description focuses on the experience of Citadel as a client in these markets,
it is important to note that the increased price competition and transparency resulting from thecurrent SEF regime also proved to be a catalyst for the entry of new liquidity providers, such as
Citadel Securities. Prior to the introduction of multilateral and transparent SEFs, clients wereunable to easily compare prices across liquidity providers, which impeded a new entrant frombeing able to clearly demonstrate that it could offer more competitive pricing than the incumbents.
Therefore, clients were likely to continue selecting the established liquidity providers for one-toone negotiations.
The introduction of pre-trade transparency and competitive execution under the current SEF
regime fundamentally altered this dynamic, and provided new liquidity providers with anopportunity to compete for client business on a more level playing field. The entry of new liquidity
providers further improves conditions for clients, as new liquidity providers introduce additionalinnovation to attract client business. For example, Citadel Securities became one of the top
liquidity providers in USD IRS by introducing firm on-screen pricing (as opposed to indicative
quotes), responding immediately to client RFQs, increasing quoted sizes, and demonstrating
dependable liquidity provision during all types of market conditions. In response to this market
competition, other liquidity providers have improved their offerings as well, further benefitingclients through better pricing and liquidity.
B. The SEF Proposal Will Erode Documented Benefits and Impede Market Evolution
The SEF Proposal significantly alters both of the beneficial aspects of the regulatory
framework detailed above:

Reinterpreting the SEF Definition. Platforms that only offer bilateral trading protocols
would now be able to qualify as a SEF. According to the SEF Proposal, a platform that
only offers single-dealer pages qualifies as a SEF as long as more than one single-dealer
page is available.5 Similarly, a platform that only offers a bilateral RFQ-to-1 trading
protocol qualifies as a SEF as long as a client is permitted to send more than one RFQto-1 sequentially;6 andEliminating Minimum Standards for Multilateral and Pre-Trade Transparent Execution.
The SEF Proposal permits all instruments to be executed on SEF via one-to-one private
negotiations, even those subject to the trade execution requirement.7

These proposals threaten to reverse the material benefits that have accrued to clients under thecurrent framework. Relegating SEFs from multilateral trading venues to nothing more than singledealer pages or an RFQ-to-1 platform, where a client can only meaningfully interact with one
liquidity provider at a time, risks fragmenting liquidity and impairing price discovery as available
quotes become more difficult to consolidate and compare. In turn, eliminating minimum standards
5

SEF Proposal at 61957.

6

SEF Proposal at 61965, FN 136.

7

SEF Proposal at 61978.
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

and allowing transactions subject to the trade execution requirement to be executed via one-to-one
private negotiations can be expected to decrease overall competition and transparency, andincrease transaction costs for clients as the market reverts to bilateral negotiations.
C. The SEF Proposal is Inconsistent with the Commodity Exchange Act
Reinterpreting the SEF Definition
Section 1a(50) of the CEA defines a SEF as “a trading system or platform in which multiple[emphasis added] participants have the ability to execute or trade swaps by accepting bids andoffers made by multiple [emphasis added] participants in the facility or system, through any meansof interstate commerce.” The proposal to allow platforms to qualify as a SEF by only offeringbilateral trading protocols, such as single-dealer pages or RFQ-to-1, is inconsistent with thisstatutory definition.
The SEF Proposal explicitly acknowledges that a single-dealer page or platform does notsatisfy the multiple-to-multiple prong of the SEF definition. 8 Similarly, the SEF Proposal
explicitly acknowledges that an RFQ-to-1 does not satisfy the multiple-to-multiple prong of the
SEF definition.9 However, the SEF Proposal asserts that a platform offering more than one singledealer page or the ability to send more than one RFQ-to-1 sequentially complies with the SEF
definition.10
This novel interpretation of the statutory definition reverses the Commission’s current
position 11 and, in practice, would render the multiple-to-multiple requirement meaningless.
Permitting a market participant to engage in multiple one-to-one negotiations is not sufficient toprovide that market participant with the ability to interact with the bids or offers of multiple
liquidity providers (as is required by the statutory SEF definition), as bids and offers are only truly
comparable when they can be obtained and traded against at the same time.
To illustrate the problems with the SEF Proposal’s approach, consider how single-dealer pages
are aggregated by Bloomberg, which appears to be the one “Single-Dealer Aggregator Platform”
referenced in the SEF Proposal (note: these single-dealer pages are currently only permitted to be
used for instruments that are not required to be executed on a SEF).12 Each single-dealer page isdisplayed separately and provides indicative pricing offered by that particular dealer. Clients areinvited to initiate a one-to-one negotiation in order to obtain an executable price for a specificinstrument. Importantly, there is no ability for clients to interact with multiple dealers
simultaneously as clients must interact with one single-dealer page at a time through one-to-one
8

SEF Proposal at 61957.

9

SEF Proposal at 61965, FN 136.

10

Id. and SEF Proposal at 61957.

11

See 78 FR 33476 (June 4, 2013) at 33498, 33563, available at:https://www.cftc.gov/sites/default/files/idc/groups/public/@lrfederalregister/documents/file/2013-12242a.pdf(“Current SEF Rules”) and SEF Proposal at 61956.
12

SEF Proposal at 62046, FN 930.
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

negotiation. Once a client obtains an executable quote from a given liquidity provider, the quote
is typically only executable for a couple of seconds, and, therefore, in practice clients do not havethe ability to obtain, and trade against, executable quotes from multiple liquidity providers at thesame time through single-dealer pages.13
The prospect of sending multiple RFQ-to-1s raises similar concerns. While a trading venue
may theoretically permit a client to send more than one RFQ-to-1 sequentially, the time required
to initiate these distinct RFQs and the time limits placed on executable quotes by liquidity
providers means that clients would not have the ability to obtain, and trade against, executable
quotes from multiple liquidity providers at the same time.
The pre-SEF trading environment consisted of clients engaging in sequential one-to-one
negotiations with individual liquidity providers. The SEF definition reflects clear congressional
intent to increase market transparency and competition by transitioning trading activity to venues
that must provide multilateral trading protocols. Notably, the Securities and Exchange
Commission (“SEC’) has interpreted the identical statutory definition of a “security-based swap
execution facility” to exclude platforms that only permit one-to-one negotiations.14 For example,
the SEC concluded a platform that aggregates single-dealer pages does not satisfy the statutory
definition since: “a participant in the aggregated single-dealer platform may only send a request to
one dealer at a time and thus would not have the ability to interact with the bids or offers of multiple
dealers simultaneously.”15 We urge the Commission to maintain its current well-reasoned legal
interpretation that only offering bilateral trading protocols does not satisfy the multiple-to-multiple
prong of the SEF definition in the CEA.
Eliminating Minimum Standards for Multilateral and Pre-Trade Transparent Execution
The CEA sets forth certain minimum standards that govern the execution of swaps on SEFs.
First, as discussed immediately above, the statutory definition of a SEF requires multiple-tomultiple execution.16 The SEF Proposal acknowledges that this definition serves as a “baseline
requirement”17 and a SEF can only offer a trading protocol that “meets the SEF definition.”18
Second, the SEF Proposal also acknowledges the clear statutory goal of promoting pre-trade pricetransparency through the regulatory framework applicable to SEFs.19
Despite acknowledging these statutory requirements, the SEF Proposal then appears tocompletely disregard them when detailing the trading protocols that SEFs would be permitted to13

We note that, in the extreme, this aspect of the SEF Proposal, combined with the proposed impartial accesschanges discussed in Section II of the letter, appear to permit a SEF to consist of nothing more than single-dealer
pages of one liquidity provider and its affiliates.
14

76 FR 10948 (Feb. 28, 2011) at 10954, available at: https://www.sec.gov/rules/proposed/2011/34-63825fr.pdf.

15

Id. at 10952, FN 33.

16

CEA Section 1a(50).

17

SEF Proposal at 61964, FN 134.

18

SEF Proposal at 61980. See also SEF Proposal at 62055.

19

See, e.g., SEF Proposal at 61981 and CEA Section 5h(e).
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

offer. For example, the SEF Proposal fails to provide a single example of a trading protocol that
does not meet the statutory definition of a SEF, even though it would appear difficult to conclude
that one-to-one private negotiations satisfy the multiple-to-multiple requirement. Similarly, theSEF Proposal acknowledges that one-to-one private negotiations do not provide pre-trade pricetransparency, but then attempts to justify this by asserting that “those market participants sending
RFQs to only one liquidity provider would be forgoing pre-trade transparency, but would be doing
so voluntarily [emphasis added].” 20 However, the statute does not provide the Commission,
market participants, or SEFs with the discretion to determine whether or not pre-trade transparency
is required when trading on a SEF. Instead, Congress provided an explicit rule of construction.21
The CEA is clear that SEF trading must be multilateral and pre-trade transparent.22 For thisreason, the Commission previously concluded that one-to-one negotiations were not permitted fortransactions required to be executed on a SEF, as otherwise “the multiple-participant-to-multipleparticipant requirement in the SEF definition and the pre-trade price transparency goal would beundermined.”23 We urge the Commission to maintain this well-reasoned legal interpretation andensure that minimum standards regarding multilateral and pre-trade transparent execution are
enforced, even if SEFs are given additional flexibility regarding permitted trading protocols. In
practice, these statutory minimum standards mean that one-to-one private negotiations, whether
through RFQ, chat or otherwise, should not be permitted for transactions required to be executedon a SEF.
D. The SEF Proposal Conflicts with Internationally-Harmonized Standards
The SEF Proposal undermines the current alignment between US rules for SEFs and EU rules
for multilateral trading facilities (“MTFs”) and organised trading facilities (“OTFs”). This may
negatively impact the existing equivalence agreement between the US and EU with respect to OTC
derivatives trading venues.24
Reinterpreting the SEF Definition
The current equivalence agreement between the US and EU is supported by there being aconsistent interpretation regarding the types of trading venues that can qualify as a SEF, MTF or
OTF. Similar to the multiple-to-multiple prong of the SEF definition, MiFID II requires MTFs
and OTFs to provide a system in which “multiple third-party buying and selling trading interests
in financial instruments are able to interact in the system.” 25
20

SEF Proposal at 62061.

21

See Current SEF Rules at 33554, FN 955.

22

The existence of these statutory requirements is one reason why drawing comparisons to the regulatory
frameworks applicable to other asset classes may be misplaced. See SEF Proposal at 61981, FN 295.
23

Current SEF Rules at 33498.

24

See https://www.cftc.gov/PressRoom/PressReleases/pr7656-17 and Commission Implementing Decision (EU)2017/2238, available at: https://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32017D2238&from=EN.
25

Article 4(1)(22) and (23) of MiFID II.
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

A trading platform that offers nothing more than single-dealer pages or RFQ-to-1 trading
functionality would not appear to satisfy this definition under MiFID II. In fact, these bilateral
trading protocols more closely resemble off-venue trading activity conducted by systematicinternalisers (“SIs”) in the EU. For example, SIs typically maintain single-dealer pages.
In the event that trading platforms only offering bilateral trading protocols qualify as a SEF,
as proposed, the current equivalence agreement may be negatively impacted. This is because EU
market participants would then be able to satisfy the EU trading obligation on US platforms thatare not considered multilateral under MiFID II, and instead resemble SIs, which are not a permitted
method for complying with the EU trading obligation.
Eliminating Minimum Standards for Multilateral and Pre-Trade Transparent Execution
The current equivalence agreement between the US and EU is also supported by the fact thatboth jurisdictions have minimum standards regarding multilateral and pre-trade transparent
execution on SEFs, MTFs and OTFs. As discussed above, MiFID II requires MTF and OTFs tooffer a multilateral system. In addition, transactions on MTFs and OTFs are subject to specificpre-trade transparency requirements.26
By failing to maintain minimum standards regarding multilateral and pre-trade transparent
execution on SEFs when providing additional flexibility regarding permitted trading protocols, theSEF Proposal risks negatively impacting the current equivalence agreement. This is because thecurrent prohibition on one-to-one negotiations for instruments subject to the US trade execution
requirement was critical in establishing comparability with EU pre-trade transparency rules, as theCommission was able to demonstrate that a market participant is always provided with multiple
executable prices pre-trade, either through the responses to a multilateral RFQ or throughaccessing the available bids and offers in an order book. In contrast, under the SEF Proposal, theseminimum standards are eliminated and EU market participants would be able to satisfy the EU
trading obligation on US platforms through one-to-one private negotiations without being subject
to any pre-trade transparency obligations as required under MiFID II.
E. The SEF Proposal Fails to Satisfy a Cost-Benefit Analysis
The cost-benefit analysis included in the SEF Proposal does not meet the statutory
requirements of Section 15(a) of the CEA. Instead of seeking to accurately quantify the costs
associated with the proposal, the SEF Proposal asserts that the Commission “currently lacks therequisite data and information to reasonably estimate them.”27 At the same time, the SEF Proposal
disregards, among others, (i) academic research, (ii) publicly available market data, (iii) current
SEF rulebooks, and (iv) other data available to the Commission as a result of its market oversight
responsibilities. We document this available information below and analyze its significance inassessing the costs and benefits of the SEF Proposal.

26

See Article 8 of MiFIR.

27

SEF Proposal at 62051.
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

Reinterpreting the SEF Definition
The SEF Proposal only engages in a cursory analysis of the impact of reinterpreting thestatutory definition of a SEF to include platforms that solely offer single-dealer pages or RFQ-to1 trading functionality. This analysis is largely limited to conclusory statements, such as “[t]heCommission believes that the proposed application of the statutory SEF registration requirement
to certain entities not currently registered should enhance the competitiveness and financial
integrity of markets since these registered SEFs would be subject to relevant SEF core
principles.”28
These types of statements gloss over the significance of the current interpretation of the SEF
definition, which has helped to facilitate a transition away from bilateral platforms, such as singledealer pages, to platforms where quotes from multiple liquidity providers can be consolidated andcompared. The SEF Proposal does not provide any of the Commission’s own observations
regarding this transition, such as (i) the opaque execution process that existed for clients prior to
the introduction of SEFs, or (ii) the benefits that have subsequently accrued to clients, such as
more competitive, transparent, and dependable on-screen pricing, better liquidity, and lower
transaction costs. In addition, the SEF Proposal does not review relevant academic research that
documents the tangible benefits of transitioning to multilateral trading platforms, including:28

Essays on the Market Structure and Pricing of Credit Derivatives.29 This research finds
that, compared to bilateral trading protocols, multilateral SEFs increase pre-tradetransparency, facilitate comparison shopping, and create direct price competition amongliquidity providers.30 Multilateral SEFs are found to reduce client trading costs in index
CDS by 40-50% compared to bilateral off-SEF trading protocols.31

Centralized trading, transparency and interest rate swap market liquidity: evidence fromthe implementation of the Dodd-Frank Act.32 This research finds that multilateral SEFs
reduce search costs for clients and make it easier for clients to trade with the liquidity
provider showing the best price.33 Prior to the emergence of SEF trading, 28% of clients
only dealt with a single liquidity provider and over 50% of clients dealt with three or fewer
liquidity providers. As clients transitioned onto multilateral SEFs in February 2014, they

SEF Proposal at 62055.

29

Junge, J., Essays on the Market Structure and Pricing of Credit Derivatives, November 2016, available at:https://infoscience.epfl.ch/record/222511/files/EPFL_TH7322.pdf.
30

Id. at pages 71 and 75.

31

Id. at page 71.

32

Benos, E., Payne, R., and Vasios, M., Centralized trading, transparency and interest rate swap market liquidity:
evidence from the implementation of the Dodd-Frank Act, Bank of England Staff Working Paper, May 2018,available at: https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2018/centralized-tradingtransparency-and-interest-rate-swap-market-liquidity-update.
33

Id. at page 26.
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

were able to easily access more liquidity providers, with only 8% dealing with a single
liquidity provider and only 20% dealing with 3 or fewer liquidity providers.34
Discriminatory pricing of over-the-counter derivatives. 35 This research finds that lesssophisticated clients pay higher transaction costs when using bilateral trading protocols,
but that transactions on multilateral RFQ platforms exhibit competitive spreads regardlessof client sophistication levels. 36 Specifically, “the use of multi-dealer RFQ platforms
removes the market power of dealers and compresses average spreads.”37

Over-the-Counter Markets.38 This research finds that client transaction costs decrease to
the extent a client can more easily find other liquidity providers, such as on a multilateral
trading venue.

The SEF Proposal does not cite any of the academic research listed above. The Commission
must take into account documented benefits of transitioning trading activity onto multilateral SEFs
when evaluating the impact of permitting a SEF to offer nothing more than single-dealer pages or
RFQ-to-1 trading functionality, where a client can only meaningfully interact with one liquidity
provider at a time. In addition, the Commission should consider potential costs relating to (a)liquidity fragmentation (as new bilateral platforms emerge and certain liquidity providers shift
liquidity provision away from multilateral platforms), (b) impaired price discovery (as available
quotes become more difficult to consolidate and compare across the market), and (c) the impact
on smaller and less sophisticated clients.
Eliminating Minimum Standards for Multilateral and Pre-Trade Transparent Execution
The SEF Proposal eliminates minimum standards for multilateral and pre-trade transparent
execution and permits all instruments to be executed via one-to-one negotiations. Whileacknowledging that providing complete flexibility regarding trading protocols may reduce “thebenefits from the existing system,”39 the SEF Proposal makes three main assertions in response:

34

Assertion #1: Providing SEFs with flexibility regarding trading protocols will “promote
pre-trade price transparency in the swaps market by allowing execution methods thatmaximize participation and concentrate liquidity during times of episodic liquidity.”40

Id. at page 26.

35

Hau, H., Hoffmann, P., Langfield, S., and Timmer, Y., Discriminatory pricing of over-the-counter derivatives,
ESRB Working Paper, December 2017, available at: https://www.esrb.europa.eu/pub/pdf/wp/esrb.wp61.en.pdf. We
note that, while the paper focuses on the FX derivatives market, its conclusions regarding the impact of multi-dealer
RFQ platforms are generally applicable across OTC markets.
36

Id. at pages 22-23.

37

Id. at page 23.

38

Duffie, D., Gârleanu, N., and Pedersen, L.H., Valuation in Over-the-Counter Markets (November 2004) at page 2,
available at: https://web.stanford.edu/~duffie/OTCmarkets.pdf.
39

SEF Proposal at 62060.

40

SEF Proposal at 61952. See also SEF Proposal at 62061.
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

Assertion #2: SEFs still have the option of offering multilateral and pre-trade transparent
trading protocols, so market participants “would not need to forgo the pre-tradetransparency associated with these means of execution.”41

Assertion #3: The proposed elimination of the made available to trade (“MAT”) process
will result in more trading on SEF in index CDS and IRS subject to the clearing mandate
and “increased potential for higher levels of pre-trade price transparency throughincreased participation.”42

We evaluate these assertions below by reference to academic research, publicly available
market data, and current SEF rulebooks.
We first reference published analysis of SDR data to detail the 2018 trading activity of index
CDS and IRS instruments subject to the clearing mandate (which is the relevant data set given the
SEF Proposal is predicated upon expanding SEF trading to encompass all instruments subject tothe clearing mandate). Current trading activity in clearing-mandated instruments can be divided
into four categories:
1. Required Transactions: On-SEF transactions in current MAT instruments (i.e.
instruments that are required to be executed on or pursuant to the rules of a SEF).
2. Permitted Transactions: On-SEF transactions in other clearing-mandated instruments(non-MAT) that are voluntarily executed on a SEF.
3. Off-SEF MAT Transactions: Off-SEF transactions in current MAT instruments thatare relying on an exemption from the trade execution requirement, such as the end-user
exemption or the inter-affiliate exemption.
4. Off-SEF Non-MAT Transactions: Off-SEF transactions in other clearing-mandated
instruments.
The charts below show 2018 trading activity in clearing-mandated index CDS and IRS
instruments. We then use this data, among others, to analyze the costs and benefits of the SEF
Proposal for each of the four categories above.

41

SEF Proposal at 62060.

42

SEF Proposal at 61984.
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

Analysis of 2018 Trading Activity in Clearing-Mandated Index CDS and IRS
Index CDS (Notional)

IRS (Notional)

IRS (DV01)

Source: Clarus Financial Technology (https://www.clarusft.com/what-traded-on-sef-in-2018/)

Page 14 of 42

Section I. The SEF Proposal Abandons Multilateral and Transparent Execution(i) Required Transactions: Costs and Benefits
The analysis of SDR data presented above clearly demonstrates that Required Transactions
are a critically important segment of the market:

For index CDS, 94% of all trading activity in clearing-mandated instruments occurs in
Required Transactions, as measured by notional.

For IRS, over 50% of on-SEF trading activity in clearing-mandated instruments occurs
in Required Transactions, as measured by DV01 (a more accurate risk-based measure,as the Commission has recognized that notional amount is not the best measure of thesize of the IRS market43).

Furthermore, Required Transactions account for an even greater proportion of dealerto-client IRS trading activity on-SEF. An analysis of Bloomberg SEF trading activity
found that Required Transactions account for approximately 75% of new trading
activity in clearing-mandated IRS instruments.44

Required Transactions account for a greater proportion of dealer-to-client IRS trading
activity on-SEF because most of the on-SEF trading activity in Permitted Transactions
occurs in FRA and OIS instruments, which are almost exclusively executed on a dealerto-dealer basis on-SEF.45

The importance of Required Transactions, particularly with respect to dealer-to-client trading
activity, means that the proposed elimination of minimum standards for multilateral and pretrade transparent execution on SEFs will have significant adverse effects and fails an objective
cost-benefit analysis. Under current Commission rules, Required Transactions are not permitted
to be executed via one-to-one private negotiations on a SEF. This has resulted in a competitiveand pre-trade transparent trading environment that has delivered tangible benefits to clients:

Haynes, R., Roberts, J., Sharma, R. and Tuckman, B., “Introducing ENNs: A Measure of the Size of Interest Rate
Swap Markets” (January 2018), available at:https://www.cftc.gov/sites/default/files/About/Economic%20Analysis/Introducing%20ENNs%20v4.pdf; see also
Remarks of Chairman J. Christopher Giancarlo before Derivcon 2018 (Feb. 1, 2018), available at:https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo35.
43“What Traded On-SEF in 2018?” Clarus Financial Technology (Feb. 12, 2019), available at:https://www.clarusft.com/what-traded-on-sef-in-2018/.
44

45

Id.
Page 15 of 42

Section I. The SEF Proposal Abandons Multilateral and Transparent ExecutionAcademic research has found that client trading costs have decreased by (a) 40-50% forindex CDS46 and (b) $7 to $11 million per day for USD IRS47 when comparing on-SEF
execution to off-SEF.48



Separate analysis of SDR data confirms that the competitive and pre-trade transparent
SEF trading environment has resulted in material pricing and liquidity benefits, withminimal price dispersion observed for Required Transactions that is “two orders ofmagnitude” lower than the price dispersion observed for off-SEF trading activity.49

The SEF Proposal does not cite to any of the research detailed above nor does the Commission
attempt to perform its own analysis of available data to assess the benefits that have accrued toclients under the current regulatory framework with respect to the execution of Required
Transactions. As a result, the Commission is unable to accurately identify the potential costs
associated with the proposal to allow all Required Transactions to be executed via one-to-one
private negotiations on a SEF.
Instead, the SEF Proposal seeks to minimize the impact on Required Transactions by making
two main assertions. We present each of these assertions in turn and detail their flaws.
SEF Proposal Assertion #1: Providing SEFs with flexibility regarding trading protocols will“promote pre-trade price transparency in the swaps market by allowing execution methods
that maximize participation and concentrate liquidity during times of episodic liquidity.”50

46

Supra note 31.

47

Supra note 32 at page 23. We note that this study leveraged data from LCH and DTCC to compare execution
costs and liquidity dynamics before and after SEFs were introduced in order to “isolate the effects of theintroduction of SEF trading on liquidity and competition” (see page 4). Price dispersion measures were used toassess execution costs, supplemented by price impact measures and quoted spread data to assess market liquidity.
Any transaction fee separately charged by a SEF to its members is not relevant for these metrics, but we note that, tothe extent it was, it would be expected to marginally reduce the identified cost savings for clients, since there are noplatform fees for off-SEF bilateral trading. Therefore, the low per-trade transaction fees currently charged bycertain SEFs do not explain the material cost savings identified in this study.
48

We note that the SEF Proposal also fails to acknowledge that at least one of the limited number of studies citedtherein highlights the importance of minimum standards for multilateral and pre-trade transparent execution, statingthat “the two-tiered market structure—at least when combined with measures limiting dealer market power,such as post-trade transparency and a requirement to put a minimum number of dealers in competition for
trades [emphasis added]—constitutes a viable alternative to all-to-all trading in swap markets.” Collin-Dufresne, P.,
Junge, B. and Trolle, A.B., “Market Structure and Transaction Costs of Index CDSs” (September 2017) at page 6,
available at: https://www.aeaweb.org/conference/2018/preliminary/paper/HA3dNy8B.
“What Traded On-SEF in 2018?” Clarus Financial Technology (Feb. 12, 2019), available at:https://www.clarusft.com/what-traded-on-sef-in-2018/.
49

50

SEF Proposal at 61952. See also SEF Proposal at 62061. Separately, we note that the assertion that swap market
liquidity is episodic conflates the frequency of executed transactions (which is by nature variable, not constant) withthe availability of bids and offers in the markets and presence of ready and willing buyers and sellers (which isconstant). The SEF Proposal does not present any compelling evidence that swaps market liquidity is in fact
episodic.
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

An analysis of the trading protocols currently offered by SEFs for Required Transactions
demonstrates that this asserted benefit is illusory. In reality, if the SEF Proposal is finalized, theonly new trading protocol expected to be offered for Required Transactions is one-to-one private
negotiations, supported via electronic RFQ, chat, or voice. This will undoubtedly reduce
competition and pre-trade transparency for the execution of Required Transactions.
This conclusion is reached through a review of current SEF rulebooks and discussions with
SEF operators. The SEF Proposal neglects to list the trading protocols that have been approved
for Required Transactions, instead implying that the market is currently limited to two options:
RFQ-to-3 or Order Book.51 This is not the case. In 2015, former Chairman Massad detailed theCommission’s approach for approving additional trading protocols, stating:“We want to make sure there is some flexibility in methods of execution as longas Dodd-Frank’s requirements are met. Earlier this year, our staff confirmedthat an auction match trading protocol was acceptable as long as the SEF
rulebook provides adequate transparency regarding the process for setting theoffer price.” 52
A review of current SEF rulebooks confirms that the Commission has allowed significant
flexibility regarding trading protocols for Required Transactions, as long as minimum standards
regarding multilateral and pre-trade transparent execution are satisfied. For example, out of the
9 SEFs53 reporting 2018 trading activity in Required Transactions for IRS, at least 6 offer voice
trading protocols54 and at least 6 offer work-up or auction trading protocols.55 The electronic
dealer-to-client SEFs have also innovated, offering new trading protocols for Required
Transactions such as Request-for-Stream (streaming firm or indicative prices), Request-forMarket (two-sided quotes can be requested), Trade-at-best (weighs factors such as price,firmness, and time), and List (quotes can be requested on multiple transactions simultaneously).
As further evidence of the current flexibility provided to SEFs by the Commission, below are 13
trading protocols listed in the BGC Derivative Markets SEF rulebook as available for Required
Transactions:56

51

See, e.g., SEF Proposal at 62057.

52

Keynote Remarks of Chairman Timothy Massad before the Swap Execution Facility Conference (October 26,2015), available at: https://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-32.
53

BGC Derivative Markets, Bloomberg SEF, DW SEF, GFI Swaps Exchange, ICAP Global Derivatives Limited,
tpSEF, Tradition SEF, trueEX, and TW SEF.
54

BGC Derivative Markets, DW SEF, GFI Swaps Exchange, ICAP Global Derivatives Limited, tpSEF, andTradition SEF.
55

BGC Derivative Markets, DW SEF, GFI Swaps Exchange, ICAP Global Derivatives Limited, Tradition SEF, andtrueEX.
56

See http://www.bgcsef.com/wp-content/uploads/2017/01/BGC_Rulebook_12-13-16.pdf.
Page 17 of 42

Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

Order Book
Fully Electronic Work-Up
Volume Match Plus
Customer Match Trading
Voice Work-up
Hybrid VoiceTechnology-Assisted Voice Trading Facility
Volume Match Plus Voice Trading Facility

Volume Match Trading
Regular Voice Trading
RFQ Voice Trading Facility
Customer Match Voice Trading Facility
Volume Match Voice Trading Facility

Comparing the trading protocols offered by SEFs for Required Transactions with thoseoffered for Permitted Transactions (where there are no regulatory restrictions) identifies only
one main difference: one-to-one private negotiations are currently offered for Permitted
Transactions but are prohibited for Required Transactions. 57 Feedback from SEF operators
confirms that offering one-to-one private negotiations for Required Transactions is the onlychange with respect to trading protocols that can be expected to directly result from the SEF
Proposal. As a result, the SEF Proposal will unquestionably reduce pre-trade transparency andcompetition for the execution of Required Transactions by allowing opaque, bilateral negotiation
to re-emerge for instruments that currently benefit from transparent, competitive execution.
SEF Proposal Assertion #2: SEFs still have the option of offering multilateral and pre-tradetransparent trading protocols, so market participants “would not need to forgo the pre-tradetransparency associated with these means of execution.”58
This line of argument appears to acknowledge the conclusion reached above, which is thatthe new trading protocols expected to be introduced for Required Transactions will reduce pretrade transparency and competition. In response, the SEF Proposal suggests that market
participants could just ignore these new trading protocols in order to preserve the benefits of thecurrent regulatory framework.
Instead of strengthening the Commission’s case, this assertion highlights the lack ofjustification for amending the current regulatory framework. If the only way to preserve thedocumented liquidity, pricing, and transparency benefits for Required Transactions is to ignore
the changes effected by the SEF Proposal, then no changes should be made. In addition, thisassertion fails to consider the important role of minimum regulatory standards in ensuring acompetitive and transparent execution process for clients on SEFs. Before the current SEF rules
were introduced, clients purportedly had the ability to choose between bilateral and multilateral
trading protocols. However, as detailed above, the establishment of minimum standards in the
SEF rules regarding multilateral and pre-trade transparent execution for Required Transactions
dramatically changed the market, empowering clients to put liquidity provides in competition
and resulting in material benefits for clients. Eliminating these minimum standards and once
again permitting one-to-one private negotiations for all Required Transactions risks reversing
many of these gains, with the associated costs of (a) decreased competition among liquidity
providers, resulting in less dependable on-screen pricing, (b) fewer new entrants providing
liquidity, and (c) impaired price discovery.
57

We note that risk mitigation services are also offered for certain Permitted Transactions, particularly FRAs, but
are not directly relevant to the execution of Required Transactions.
58

SEF Proposal at 62060.
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

We note that the negative impact of eliminating the current minimum standards will only
increase if the Commission modifies the SEF Proposal to remove the prohibition on preexecution communications for instruments that are subject to the trade execution requirement.59
In this scenario, market participants could bilaterally negotiate a transaction off-SEF and thenleverage a one-to-one private trading protocol offered by a SEF to merely formalize the alreadyagreed transaction terms, with the SEF more closely resembling a trade capture facility insteadof a venue for transparent and competitive execution.
(ii) Permitted Transactions: Costs and Benefits
Permitted Transactions are already executed on SEFs and there are no regulatory restrictions
regarding the trading protocols that can be used. This would remain unchanged under the SEF
Proposal, and therefore, there is no obvious benefit for Permitted Transactions.
In contrast, there are potential costs for Permitted Transactions that the SEF Proposal has
failed to consider. Research has shown that the multilateral and pre-trade transparent execution
process on SEFs for Required Transactions has positive spill-over effects for Permitted
Transactions, improving liquidity and reducing transaction costs.60 Research has also shownthat multilateral SEFs reduce search costs for clients and make it easier for clients to trade withthe liquidity provider showing the best price. 61 Eliminating these minimum standards may,therefore, impose the same costs detailed above in paragraph (i) with respect to Required
Transactions. These costs are primarily relevant for IRS, as only 2% of trading activity inclearing-mandated index CDS is in Permitted Transactions.
(iii) Off-SEF MAT Transactions: Costs and Benefits
Off-SEF MAT Transactions rely on an exemption from the trade execution requirement, suchas the end-user exemption or the inter-affiliate exemption. The SEF Proposal does not propose
modifying the scope of these exemptions, and therefore there is no obvious cost or benefit forthis category of transactions.
(iv) Off-SEF Non-MAT Transactions: Costs and Benefits
Under the SEF Proposal, Off-SEF Non-MAT transactions in clearing-mandated index CDS
and IRS will be required to be traded on a SEF if the instrument is listed by a SEF. This proposed
expansion of the trade execution requirement is referenced to justify the elimination of minimum
standards for multilateral and pre-trade transparent execution on SEFs.
59

See Keynote Address of Chairman J. Christopher Giancarlo Before the ABA Business Law Section, Derivatives& Futures Law Committee Winter Meeting (Jan. 25, 2019), available at:https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo63.
See supra note 29 at page 71 and “What Traded On-SEF in 2018?” Clarus Financial Technology (Feb. 12, 2019),
available at: https://www.clarusft.com/what-traded-on-sef-in-2018/.
60

61

Supra note 33.
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

SEF Proposal Assertion #3: The proposed elimination of the MAT process will result in more
trading on SEF in index CDS and IRS subject to the clearing mandate and “increased potential
for higher levels of pre-trade price transparency through increased participation.”62
In order to evaluate this assertion, we reference the SDR data detailed above to examine OffSEF Non-MAT transactions:
For index CDS, Off-SEF Non-MAT transactions account for only 1% of trading activity inclearing-mandated instruments. Therefore, in contrast to the assertion in the SEF Proposal,
expanding the trade execution requirement to cover these instruments will not increase overallmarket transparency.
For IRS, Off-SEF Non-MAT transactions account for approximately one-third of trading
activity in clearing-mandated instruments:


We agree that some of these instruments are suitable for SEF trading, including fixedto-float swaps in currencies other than USD, EUR, or GBP and certain commonly
traded forward-starting swaps (e.g. 1Y1Y and 5Y5Y). However, market transparency
is only improved by bringing additional instruments onto SEF if the relevant trading
protocols are multilateral and transparent. Continuing to transact these instruments via
one-to-one negotiations, as permitted by the SEF Proposal, would not represent achange to the status quo.



The suitability of SEF trading is less apparent for other Off-SEF Non-MAT
instruments.
o Short-dated FRA and OIS transactions account for more than 60% of the trading
activity,63 and SDR data shows that 93% of these transactions are one year or lessin duration.64
o Fixed-to-float swaps account for most of the remaining trading activity, 65 and acloser analysis finds that many of these transactions are relatively custom andbespoke in nature, with (a) 75% having forward-starting effective dates (including
IMM), and (b) 10% having back-starting effective dates (indicating compression
activities).66

62

SEF Proposal at 61984.

“What Traded Off-SEF in 2018?” Clarus Financial Technology (Feb. 6, 2019), available at:https://www.clarusft.com/what-traded-off-sef-in-2018/.
63

64

Id.

65

Id.

66

Id.
Page 20 of 42

Section I. The SEF Proposal Abandons Multilateral and Transparent Executiono In addition, many of the more commonly-traded forward-starting swaps are
executed as part of a package transaction with Treasury futures, and the SEF
Proposal has not explained how these packages will be brought onto SEF without
amending CME Rule 538, which currently prohibits a swap from being traded on a
SEF if it is part of an invoice spread package.
Overall, the proposed expansion of the trade execution requirement will increase costs andcomplexity for market participants, while failing to meaningfully increase market transparency,
as the status quo of one-to-one bilateral negotiations will continue for today’s non-MAT
instruments, but will now be labeled SEF execution.
We note the assertion that expanding the trade execution requirement will result in greater
market transparency becomes even weaker to the extent the trade execution requirement is
ultimately expanded less than initially proposed, including as a result of adopting prescriptive
criteria that serve to limit the number of new instruments that are brought into scope.67(v) Conclusion: Costs and Benefits
The current SEF framework has successfully promoted the trading of swaps on SEFs while
increasing pre-trade transparency, consistent with the statutory objectives in the CEA.68 96% oftrading activity in clearing-mandated index CDS is already executed on-SEF, while 65% oftrading activity (based on DV01) in clearing-mandated IRS is already executed on-SEF. Overall
SEF volumes have increased significantly since SEFs were first introduced in late 2013 and since
the trade execution requirement was first introduced in February 2014.69
Much of this on-SEF trading activity is in Required Transactions, which represent a key
portion of dealer-to-client trading activity in particular. Current Commission standards requiring
multilateral and pre-trade transparent execution for Required Transactions has resulted inmaterial benefits for clients, including lower transaction costs and increased liquidity,
competition, and transparency. As detailed above, the cost-benefit analysis does not support
allowing transactions currently subject to the trade execution requirement to be executed via oneto-one private negotiations, which would lead to:Required Transactions: Material costs for both index CDS and IRS, as allowing oneto-one private negotiations reduces pre-trade transparency and competition. On theother hand, no benefits are identified, as SEFs already have been provided withsignificant flexibility regarding trading protocols (other than one-to-one negotiations).

67

See Keynote Address of Chairman J. Christopher Giancarlo Before the ABA Business Law Section, Derivatives& Futures Law Committee Winter Meeting (Jan. 25, 2019), available at:https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo63.
68

CEA Section 5h(e).

“What Traded On-SEF in 2018?” Clarus Financial Technology (Feb. 12, 2019), available at:https://www.clarusft.com/what-traded-on-sef-in-2018/.
69

Page 21 of 42

Section I. The SEF Proposal Abandons Multilateral and Transparent ExecutionPermitted Transactions: Additional costs for IRS, as the multilateral and pre-tradetransparent execution process on SEFs for Required Transactions has positive spillover effects for swaps that are voluntarily executed on SEFs. On the other hand, nobenefits are identified, as SEFs already have complete flexibility regarding permitted
trading protocols for these transactions under current Commission rules.



Off-SEF Non-MAT Transactions: Additional costs for IRS, as market participants must
transition the execution of relatively custom and bespoke instruments onto SEFs. On
the other hand, minimal potential benefits are identified, as almost no clearingmandated index CDS is traded off-SEF and many of the IRS instruments are shortdated OISs and FRAs, forward-starting swaps that are part of invoice spread packages
that may not be able to be traded on SEF at all unless changes are made to CME Rule
538, or more custom and bespoke swaps that will continue to be negotiated bilaterally
through one-to-one trading protocols.

The failure to satisfy a cost-benefit analysis is even more stark when viewed in the context
of trading activity by category. For index CDS, 96% of trading activity in clearing-mandated
instruments is already executed on-SEF, with almost all in Required Transactions. The costs
that would result for these transactions cannot be justified by bringing another 1% of trading
activity onto SEFs. For IRS, 65% of trading activity (based on DV01) in clearing-mandated
instruments is already executed on-SEF, with over half in Required Transactions. The costs thatwould result for these transactions cannot be justified by bringing short-dated OISs and FRAs
and relatively custom and bespoke fixed-to-float swaps onto SEFs to be negotiated bilaterally
through one-to-one trading protocols.
We note that the cost-benefit analysis moves even further against the SEF Proposal to theextent the proposal is modified to allow pre-execution communications away from a SEF for
Required Transactions or the trade execution requirement is ultimately expanded less thaninitially proposed, including as a result of adopting prescriptive criteria that serve to limit the
number of new instruments that are brought into scope.
F. Suggested Alternatives
We urge the Commission to consider a more tailored approach that is consistent with statutory
requirements and international standards, and mitigates many of the potential costs detailed above.
First, the Commission should maintain its current legal interpretation of the SEF definition topreclude platforms that solely offer bilateral trading protocols, such as single-dealer pages or RFQto-1s.
Second, we support the Commission providing SEFs with additional flexibility relating topermitted trading protocols by developing a more formal process for staff to review and approve
new trading protocols. However, minimum standards requiring multilateral and pre-tradetransparent execution on SEFs must be retained, as is required by the CEA, such that one-to-one
private negotiations are not permitted for transactions that are required to be executed on a SEF.
Limited exemptions from this prohibition are appropriate to maintain for block trades and certain
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Section I. The SEF Proposal Abandons Multilateral and Transparent Execution

bespoke package transactions that are not required to be executed on a SEF. We note that thisapproach is consistent with the U.S. Department of the Treasury recommendations, which
specifically note the importance of maintaining multilateral and pre-trade transparent execution on
SEFs.70
Third, in order to further promote pre-trade transparency as required by the CEA, theCommission could consider replacing the current requirement for every SEF to offer an Order
Book with less prescriptive principles designed to improve the execution process for clients. For
example, (i) a SEF should not be permitted to limit the number of liquidity providers that a client
can include on an RFQ, (ii) any SEF participant should have the ability to display firm executableprices on the SEF that are differentiated from indicative prices and to make them accessible to allother SEF participants, and (iii) a SEF should provide full interaction between its available trading
protocols such that, before trading, clients are always made aware of whether a better firm price isbeing offered somewhere else on the platform.
This alternative approach preserves the benefits of the current system while codifying a lessprescriptive set of requirements for SEFs relating to permitted trading protocols. Consistent withstatutory requirements, this approach is designed to promote SEF trading and increase pre-tradetransparency.

70

Supra note 3.
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Section II. The SEF Proposal Endorses Anticompetitive Practices by SEFs

II.

The SEF Proposal Endorses Anticompetitive Practices by SEFs

The SEF Proposal fundamentally re-interprets the statutory requirement for SEFs to provide
market participants with impartial access in order to permit SEFs to engage in a variety of
discriminatory practices. These discriminatory practices will negatively impact market
competition and liquidity, as new or smaller liquidity providers may be blocked from accessing
necessary liquidity pools and clients may be deprived of any opportunity to access the uniqueliquidity pools and trading protocols offered by trading venues that historically catered to thedealer-to-dealer segment of the market.
Below, we detail the benefits of the current regulatory framework and the expected adverse
impacts of the SEF Proposal. We then explain how the proposals are inconsistent with statutory
requirements in the CEA, conflict with internationally-harmonized standards, and fail to satisfy acost-benefit analysis. We also note that these proposals are inconsistent with the recommendations
made by the U.S. Department of the Treasury in its 2017 Capital Markets Report, which
specifically note the importance of maintaining impartial access to SEFs.71 Finally, we provide
alternative suggestions that are designed to further streamline the SEF regime in a manner that is
consistent with the CEA, while preserving, and building upon, the documented benefits realizedby market participants.
A. The Current Regulatory Framework Has Provided Material Benefits to Investors
We leverage the experience of Citadel Securities as a new liquidity provider to describe how
the dealer-to-dealer segment of the swaps market evolved as a result of the implementation of thestatutory requirement for SEFs to provide market participants with impartial access.
Dealer-to-dealer trading activity typically occurs on trading venues operated by interdealer
brokers (“IDBs”), as liquidity providers tend to avoid negotiating transactions directly with one
another for competitive reasons. Prior to the introduction of SEFs, restrictive membership criteria
were used to limit access to these IDB trading venues to a select group of incumbent liquidity
providers. For example, membership was often explicitly limited to banks that were self-clearing
members at a CCP.
These access limitations ensured that the incumbent liquidity providers were insulated fromcompetition, as potential new liquidity providers were blocked from accessing necessary pools of
liquidity for pricing and hedging purposes. Without access to the dealer-to-dealer segment of themarket, it was practically impossible for a new entrant to provide liquidity to clients.
The Commission’s SEF rules dismantled previously existing access barriers by implementing
the statutory requirement for SEFs to provide market participants with impartial access. 72 The
final SEF rules clarified that selective membership criteria would be prohibited, such as requiring

71

Supra note 3.

72

CEA Section 5h(f)(2)(B)(i).
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Section II. The SEF Proposal Endorses Anticompetitive Practices by SEFs
self-clearing membership at a CCP,73 as well as discriminatory fee structures.74 In addition, theCommission issued subsequent guidance to address other access barriers that SEFs wereattempting to implement relating to membership criteria and trading protocols.75
Implementing impartial access standards had an immediate impact for IRS and index CDS
trading activity on SEFs. With greater certainty regarding access to the dealer-to-dealer market,
new liquidity providers emerged in both IRS and index CDS.76 For example, Citadel Securities
has become one of the top liquidity providers in USD IRS – and while innovation and competitive
differentiation fueled that growth – Citadel Securities may have never been able to enter the market
at all without the implementation of impartial access standards. The emergence of new liquidity
providers has benefited clients by increasing price competition, reducing transaction costs,
diversifying sources of liquidity, and leading to innovations such as the provision of firm on-screen
pricing.
While the above description focuses on the experience of Citadel Securities as a new liquidity
provider in these markets, it is important to note that the access limitations previously employed
by IDBs also prevented clients from accessing the competitive pricing and liquidity found on these
trading venues. The current implementation of impartial access has removed many of the moreblatant barriers that prevented clients from accessing certain SEFs, but, as acknowledged in the
SEF Proposal, additional barriers remain, such as the practice of “post-trade name give-up” andthe lack of average pricing functionality.77 Citadel, like many clients, continues to support theCommission addressing these remaining barriers in order to facilitate client access to a wider rangeof SEFs.78
B. The SEF Proposal Will Erode Documented Benefits and Impede Market Evolution
The SEF Proposal fundamentally alters the current impartial access standards by allowing
SEFs to discriminate among market participants, as long as they are not considered “similarly
situated.” 79 The SEF Proposal allows each SEF the discretion to determine which market
participants should be considered “similarly situated.”80
73

Current SEF Rules at 33508.

74§37.202(a)(3).

75

Staff Guidance on Swap Execution Facilities Impartial Access (November 14, 2013), available at
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/dmostaffguidance111413.pdf.
See, e.g., “New players break into credit derivatives”, FT (Nov. 17, 2015), available at:https://www.ft.com/content/22b83fa4-8c6e-11e5-8be4-3506bf20cc2b.
76

77

SEF Proposal at 61964, FN 129.

See, e.g., “Brokers defy BlackRock over average pricing on Sefs,” Risk.net (Aug. 27, 2015), available at:https://www.risk.net/derivatives/2423396/brokers-defy-blackrock-over-average-pricing-sefs; and Managed Funds
Association Position Paper on Why Eliminating Post-Trade Name Disclosure Will Improve the Swaps Market(March 31, 2015), available at: https://www.managedfunds.org/wp-content/uploads/2015/04/MFA-Position-Paperon-Post-Trade-Name-Disclosure-Final.pdf.
78

79

SEF Proposal at 61993.

80

Id.
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Section II. The SEF Proposal Endorses Anticompetitive Practices by SEFs

In practice, this would permit the re-introduction of membership criteria designed to insulate
incumbent liquidity providers from competition by blocking access to the dealer-to-dealer segmentof the market. Under the SEF Proposal, it appears that a SEF would be permitted to limit
membership in the following ways:81
Membership Criteria

Anticompetitive Implication

Self-clearing members of a CCP for
OTC derivatives

Excludes (i) new or smaller liquidity providers
that do not have a self-clearing membership and(ii) clients

Registered swap dealers

Excludes (i) new or smaller liquidity providers
that may be floor traders and (ii) clients

Banks or liquidity providers with aminimum amount of Tier 1 capital

Excludes (i) non-bank liquidity providers and(ii) clients

Liquidity providers that have been“enabled” by, or have bilateral
documentation with, a minimum
number of other liquidity providers

Excludes (i) new or smaller liquidity providers
and (ii) clients

Liquidity providers with a minimum
amount of transaction volume

Excludes (i) new or smaller liquidity providers
and (ii) clients

These same criteria could also be used to limit the types of entities that are eligible to provide
liquidity on dealer-to-customer SEFs. Similar discrimination would also be permitted by SEFs
when applying trading protocols or setting fees.82
This type of discriminatory treatment is prohibited under current Commission rules. 83
Allowing these types of practices will negatively impact market competition and liquidity, as newor smaller liquidity providers may be blocked from accessing the dealer-to-dealer segment of themarket, curtailing their ability to offer liquidity to clients. In turn, clients may be permanently
blocked from certain SEFs, depriving them of any opportunity to access the liquidity and trading
protocols offered by those SEFs, and impeding natural market evolution.
C. The SEF Proposal is Inconsistent with the Commodity Exchange Act
The CEA requires SEFs to “provide market participants with impartial access to the market.”84
Importantly, this statutory requirement applies to all market participants, not just “similarly
situated” market participants. If Congress had intended to limit the application of this requirement,

81

See SEF Proposal at 61993-95.

82

See SEF Proposal at 61995-97.

83

See supra notes 73-75.

84

CEA Section 5h(f)(2)(B)(i).
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Section II. The SEF Proposal Endorses Anticompetitive Practices by SEFs
it could have easily modified the provision to require SEFs to “provide similarly situated market
participants with impartial access to the market.” Congress did not elect to do so.
By proposing to limit the impartial access requirement to “similarly situated” market
participants, and providing SEFs with the discretion to define “similarly situated,” the SEF
Proposal overrides clear congressional intent and eviscerates the statutory requirement. As
described above, the proposed interpretation of impartial access will permit a host of
discriminatory practices designed to wall-off certain SEFs and limit access to a handful of bankliquidity providers.85
The SEF Proposal attempts to justify this proposed interpretation by arguing that the CEA does
not mandate an all-to-all trading environment.86 However, the SEF Proposal then renders thisargument moot by acknowledging that an all-to-all trading environment has not developed under
its current interpretation of impartial access. 87 Therefore, by definition, the current impartial
access standards do not mandate an all-to-all trading environment. Instead, the current impartial
access standards have required SEFs to remove discriminatory barriers that historically prevented
new liquidity providers from entering the market and clients from selectively accessing the uniqueliquidity pools and trading protocols offered by IDB trading venues. This removal of
discriminatory access barriers, as required by the CEA, has resulted in greater competition andmarket-led innovation.
The SEF Proposal also points to a separate statutory provision that requires SEFs to “establish
and enforce compliance with any rule of the swap execution facility, including [. . .] any limitationon access to the swap execution facility.”88 Rules of statutory construction dictate that, to theextent possible, these two provisions must be interpreted in a manner that does not create a conflict.
In this regard, we note that the impartial access requirement is clear and unqualified,89 and theprovision above appears in a separate subsection of the CEA. Together, these two statutory
provisions result in the conclusion that SEFs may have rules that limit access to the trading venue,
but such rules (similar to all other SEF rules) must be consistent with the separate impartial accessrequirement. For example, SEFs are permitted to establish participant eligibility criteria, such as
those set forth in each SEF’s rulebook today. However, such participant eligibility criteria must
be impartial and non-discriminatory, instead focusing on topics such as whether the prospective
member is in good standing, solvent, an ECP, not subject to a statutory disqualification, andproperly licensed. In addition, SEFs are permitted to establish rules to deny, suspend, or
permanently bar members from the venue based on their trading activities, including as part ofdisciplinary proceedings or emergency actions. However, again, these rules must be applied in an
impartial and non-discriminatory manner.
85

This conclusion is supported by the access barriers previously employed by IDBs and the several documented
instances of anticompetitive behavior by the incumbent liquidity providers in the OTC derivatives markets (e.g., In
Re Credit Default Swaps Antitrust Litigation)
86

SEF Proposal at 61993.

87

SEF Proposal at 62062.

88

CEA Section 5h(f)(2)(A) and SEF Proposal at 61993.

89

See CEA Section 5h(f)(2)(B)(i).
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Section II. The SEF Proposal Endorses Anticompetitive Practices by SEFs

Instead of the straightforward interpretation above, the SEF Proposal attempts to create aconflict between these two statutory provisions in order to justify limiting the scope of the clear
and unqualified impartial access requirement. As a result, the SEF Proposal overrides clear
statutory intent in order to permit SEFs to discriminate against specific types of market
participants.
The discussion above highlights that the SEF Proposal is also inconsistent with section 15(b)of the CEA, which requires the Commission to “endeavor to take the least anticompetitive means”
in achieving its policy objectives. If the policy goal is to not mandate an all-to-all trading
environment, then the proposed revisions to its current impartial access standards are unnecessary
since an all-to-all trading environment has not developed under the current interpretation of
impartial access. Permitting SEFs to discriminate against specific types of market participants will
have material anticompetitive effects that particularly disadvantage new or smaller liquidity
providers and clients.
D. The SEF Proposal Conflicts with Internationally-Harmonized Standards
The current equivalence agreement between the US and EU is supported by there being
consistent standards regarding access to SEFs, MTFs, and OTFs. Similar to the impartial accessrequirement in the CEA, MiFID II requires MTFs and OTFs to establish non-discriminatory rules
governing access. 90 ESMA issued additional guidance that clearly prohibits the same accessbarriers currently prohibited by the Commission relating to membership criteria and trading
protocols, including self-clearing membership, minimum trading activity, or “enablements” byother liquidity providers.91
By replacing the current impartial access standards with an interpretation that permits SEFs todiscriminate against specific types of market participants, the SEF Proposal risks negatively
impacting the US-EU equivalence agreement. This is because certain SEFs may impose
discriminatory access criteria that have the effect of preventing EU clients or new EU liquidity
providers, among others, from fairly accessing the venue.
E. The SEF Proposal Fails to Satisfy a Cost-Benefit Analysis
The SEF Proposal only engages in a cursory analysis of the impact of reinterpreting thestatutory requirement for SEFs to provide market participants with impartial access. This analysis
largely consists of circular reasoning, which asserts that (i) the main effect of the proposal is to notmandate an all-to-all trading environment, and (ii) since an all-to-all trading environment has notdeveloped under the Commission’s current interpretation of impartial access, “costs to market

90

MiFID II Article 18(3).

91ESMA Q&A on MiFID II and MiFIR market structure topics, Section 5.1, Question 3, available at:https://www.esma.europa.eu/sites/default/files/library/esma70-872942901-38_qas_markets_structures_issues.pdf.
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Section II. The SEF Proposal Endorses Anticompetitive Practices by SEFs
participants may not change much from the current situation.”92 This analysis is deeply flawedand does not meet the statutory requirements of Section 15(a) of the CEA.
First, the SEF Proposal fails to accurately assess the practical impact of permitting SEFs todiscriminate against specific types of market participants. The current impartial access standards
have resulted in SEFs dismantling barriers that were used to limit access to IDB trading venues toa select group of bank liquidity providers. Permitting these barriers to be re-introduced will resultin significant costs for market participants that have nothing to do with whether or not an all-to-all
trading environment exists.
For example, paragraph (B) above illustrates how SEFs will be able to discriminate against
new or smaller liquidity providers. Without reliable and secure access to the dealer-to-dealer
segment of the market, it will be practically impossible for these firms to provide liquidity toclients. As a result, the SEF Proposal can be expected to result in reduced competition amongliquidity providers, reversing the observed benefits of lower transaction costs and diversified
sources of liquidity under the current SEF rules.93 Market research has documented efforts bybank liquidity providers to retain market power in certain OTC derivatives by avoiding theCommission’s current impartial access requirements.94 These efforts to insulate themselves fromcompetition will now be expressly permitted in the SEF Proposal.
In addition, clients will be prohibited from selectively accessing the unique liquidity andtrading protocols offered by IDB trading venues, as the SEF Proposal explicitly endorses dealeronly SEFs.95 Market research has found that SEFs operated by IDBs may offer more competitive
pricing in certain instruments compared to other SEFs.96 SEFs operated by IDBs also offer uniquetrading protocols, given the use of voice brokers. While the SEF Proposal asserts that an expanded
set of trading protocols will be available to market participants, it fails to acknowledge that manyof these trading protocols are only available on SEFs operated by IDBs and, therefore, the revisedinterpretation of impartial access will result in clients being unable to access many of them.
Similarly, clients may be unable to comply with the expanded trade execution requirement
contemplated in the SEF Proposal, as certain instruments may only be available for trading on
SEFs operated by IDBs.
The SEF Proposal also fails to evaluate the impact on market-wide liquidity and pricediscovery. Despite acknowledging that “[t]he Commission has further observed that when markets
are open and transparent, prices are more competitive and markets are more efficient,” 97 theproposed interpretation of impartial access will result in the exact opposite, as each SEF can limit
membership to a specific subset of market participants. This will fragment liquidity, impair price92

SEF Proposal at 62062.

93

See supra note 29 at page 69 and supra note 32 at page 23.

94

Supra note 32 at page 30.

95

SEF Proposal at 61995.

96

Quantifying Interest-Rate Swap Order Book Liquidity, Greenwich Associates (Q1 2016), available at:https://www.greenwich.com/fixed-income-fx-cmds/quantifying-interest-rate-swap-order-book-liquidity.
97

SEF Proposal at 61982.
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Section II. The SEF Proposal Endorses Anticompetitive Practices by SEFs

discovery, and reduce transparency, as the various barriers imposed by SEFs will make it moredifficult for market participants to access, consolidate and compare available quotes.
Second, the SEF Proposal’s focus on not mandating an all-to-all trading environment ismisplaced. As acknowledged in the SEF Proposal, the Commission’s current interpretation of
impartial access has not resulted in the market transitioning to an all-to-all trading environment.98
Therefore, the current impartial access standards do not mandate an all-to-all trading environment.
Importantly, however, they do provide the ability for such an evolution to organically occur by
dismantling artificial barriers. By endorsing dealer-only SEFs and a two-tier market structure,99
the Commission is inappropriately dictating market structure outcomes. To the extent the SEF
Proposal is correct that “[m]aintaining certain types of markets, such as the dealer-to-dealer
market, should be beneficial to all market participants, including participants in the dealer-to-client
market,”100 then such an outcome should be expected to naturally occur. The Commission should
not be reversing existing rules in order to preserve the status quo and restrict market-led innovationby allowing improper discrimination against specific types of market participants.
F. Suggested Alternatives
We urge the Commission to reconsider its proposed approach on impartial access. As
discussed above, the current impartial access standards have correctly implemented the statutory
mandate and have resulted in the dismantling of barriers that were used to limit access to IDB
trading venues to a select group of bank liquidity providers.
The Commission should re-affirm its current impartial access standards and formally codify
the additional guidance that was issued to address other access barriers that SEFs were attempting
to implement relating to membership criteria and trading protocols.101 This includes prohibiting(i) enablement mechanisms, (ii) criteria designed to discriminate against specific types of firms,(such as by referencing self-clearing membership, a minimum amount of capital, a certain type ofregistration or incorporation, or a minimum level of trading activity), (iii) criteria designed toprevent a firm from being both a liquidity taker and a liquidity provider, and (iv) requirements forbilateral documentation between trading counterparties in order to execute cleared swaps. It is
critical that the impartial access standards continue to apply to all aspects of a SEF’s operation,
including membership criteria, trading protocols, and fees, in order to prevent anticompetitive
practices. This alternative approach would follow the U.S. Department of the Treasury
recommendations, which recognize the importance of maintaining impartial access on SEFs.102

98

SEF Proposal at 62062.

99

SEF Proposal at 61995 and 62060.

100

SEF Proposal at 62060.

101

Supra note 75.

102

Supra note 3.
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Section III. The SEF Proposal Introduces Material Risks to the Clearing Workflow

III. The SEF Proposal Introduces Material Risks to the Clearing Workflow
The SEF Proposal fundamentally alters current execution-to-clearing operational workflows
for SEF trading by failing to preserve the current STP standards. Cleared swaps executed on a
SEF would no longer be required to be submitted to a CCP within 10 minutes, raising the prospectof material delays between execution and clearing that lead to unnecessary market, credit, andoperational risks. In addition, bilateral breakage agreements between each pair of trading
counterparties would now be permitted for cleared swaps on SEFs, disrupting current trading
relationships and reducing access to trading counterparties.
Below, we detail the benefits of the current regulatory framework and the expected adverse
impacts of the SEF Proposal. We then explain how these proposals are inconsistent with statutory
requirements in the CEA, conflict with internationally-harmonized standards, and fail to satisfy acost-benefit analysis. Finally, we provide alternative suggestions that are designed to further
streamline the SEF regime in a manner that is consistent with the CEA, while preserving the
documented benefits realized by market participants.
A. The Current Regulatory Framework Has Provided Material Benefits to Investors
We leverage the experience of both Citadel and Citadel Securities to describe the material
benefits for all market participants trading on SEFs that have directly resulted from theCommission’s current STP standards.
Prior to the introduction of SEFs, there was a lack of market consistency regarding theexecution-to-clearing workflow for OTC derivatives that were intended to be cleared. This lackof consistency unnecessarily complicated the trading of cleared swaps, which should be moreaccessible to market participants since central clearing eliminates bilateral counterparty credit risk
and the need for complex bilateral trading and credit support documentation between each andevery pair of potential trading counterparties.
Below, we list the issues that led to this lack of consistency and detail how they were addressedby the Commission’s STP standards:


Submission timeframes. It would often take hours, if not days, following execution fora transaction to be submitted to, and accepted for clearing by, a CCP. This extended
length of time between execution and clearing acceptance introduced risks for bothmarket participants and CCPs. In particular, these delays increased market, credit, andoperational risks for market participants, as a transaction could not be consideredsuccessfully executed until it was accepted for clearing. In addition, these delays
impaired the ability of CCPs to monitor current market trading activity and the numberof transactions pending submission to clearing, information that is important for a CCP’srisk management framework, particularly during volatile market conditions.
In order to minimize delays between execution and clearing acceptance, the Commission
established STP standards that require (i) SEFs to submit all cleared swaps to a CCP no
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Section III. The SEF Proposal Introduces Material Risks to the Clearing Workflow
later than 10 minutes after execution,103 and (ii) CCPs to accept or reject transactions
within 10 seconds of receipt.104


Clearing certainty. There was little pre-trade visibility regarding whether a potential
transaction would successfully clear and a lack of consistency regarding what would
happen if the transaction was subsequently rejected from clearing. When combined withthe submission delays described above, many market participants concluded that thisuncertainty introduced an unacceptable level of market, credit and operational risk. As
a result, bilateral breakage agreements were introduced to manage, and allocate
responsibility for, these potential risks arising during the period between execution andclearing acceptance. This re-introduction of bilateral trading documentation undermined
one of the main benefits of central clearing and limited client access to a broader rangeof trading counterparties.
In order to provide greater certainty to market participants that a transaction will
successfully clear, the Commission established STP standards that require pre-execution
credit checks by a client’s clearing member to ensure available clearing capacity. 105 In
the rare circumstance that a transaction passes the pre-execution credit check but
nonetheless is rejected by the CCP, the STP standards permit the transaction to be
resubmitted for clearing in order to address operational or clerical errors within one hourof the CCP’s rejection.106 In the event a transaction cannot be successfully cleared, it isconsidered to be void ab initio.107 This approach provides a consistent standard for all
SEF transactions that are intended to be cleared, and obviates the need for bilateral
breakage agreements, which were subsequently prohibited by the Commission for SEF
transactions.108

The Commission’s STP standards have been successfully implemented by the industry since2013 and have significantly enhanced the SEF trading environment. The combination of preexecution credit checks and well-defined submission timeframes has reduced market, credit, andoperational risks for SEF trading, and has focused market participants on streamlining theexecution-to-clearing workflow. As a result, the void ab initio backstop has rarely been used, but
has promoted SEF trading by enabling clients to seamlessly trade cleared swaps without complex
bilateral documentation and with a wider range of trading counterparties. This ease of trading

103

CFTC Letter No. 15-67 (Dec. 21, 2015), available at:
http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/15-67.pdf.
“Staff Guidance on Swaps Straight-Through Processing” (Sept. 26, 2013), available at:
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/stpguidance.pdf.
104

105

Id.

106

CFTC Letter No. 17-27 (May 30, 2017), available at:https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/17-27.pdf.
107

Supra note 104.

108

Staff Guidance on Swap Execution Facilities Impartial Access (November 14, 2013) at FN 3, available at
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/dmostaffguidance111413.pdf.
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Section III. The SEF Proposal Introduces Material Risks to the Clearing Workflow

cleared swaps on SEFs has also facilitated the entry of new liquidity providers, such as Citadel
Securities, that do not have legacy bilateral trading documentation in place with clients.
B. The SEF Proposal Will Erode Documented Benefits and Impede Market Evolution
The SEF Proposal elects to retain only some of the current STP standards that have beensuccessfully implemented by SEFs and market participants.
Submission timeframes. The SEF Proposal eliminates the requirement for SEFs tosubmit transactions to a CCP no later than 10 minutes after execution, but retains therequirement that CCPs must accept or reject transactions within 10 seconds of receipt.109



Clearing certainty. The SEF Proposal retains pre-execution credit checks and therequirement that transactions are to be considered void ab initio if rejected by a CCP for
credit reasons. 110 However, the SEF Proposal eliminates void ab initio and theaccompanying prohibition on breakage agreements for transactions that are rejected by a
CCP due to operational or clerical errors, and SEFs are provided with complete flexibility
to establish bespoke error trade policies in these circumstances.111

These proposed changes would fundamentally alter current operational workflows for SEF
trading, and introduce unnecessary market, credit, and operational risk. By eliminating therequirement for SEFs to submit executed transactions to a CCP within a prescribed timeframe,market participants and CCPs lose predictability regarding the submission process. The prospectof material delays between execution and clearing submission increases market, credit andoperational risks for trading counterparties, and makes it more likely that bilateral breakage
agreements would be introduced for cleared swaps where permitted under the SEF Proposal. As
detailed above, bilateral breakage agreements undermine key benefits of trading cleared swaps on
SEFs, including ease of trading and access to a wider range of trading counterparties, and impede
market evolution, as certain trading protocols (e.g. anonymous trading) are based on theassumption that bilateral trading documentation is not required for cleared swaps. The prospectof breakage being owed from one trading counterparty to another for a cleared swap also serves asa material impediment to the entry of new liquidity providers, as counterparty credit assessments
and the negotiation of bilateral documentation may be required in order to establish a trading
relationship.
C. The SEF Proposal is Inconsistent with the Commodity Exchange Act
The CEA requires SEFs to ensure the financial integrity of swaps entered on or through theirfacilities, including with respect to clearing and settlement.112 The Commission’s current STP
standards are designed to implement this statutory requirement by establishing, among others,
109

SEF Proposal at 62022-23.

110

SEF Proposal at 62001 and 62023-24.

111

SEF Proposal at 62001.

112

CEA Section 5h(f)(7).
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Section III. The SEF Proposal Introduces Material Risks to the Clearing Workflow

consistent clearing submission timeframes for SEFs and procedures for addressing clearing
rejections.113
In contrast, the SEF Proposal has failed to demonstrate how the proposed STP changes are
consistent with the CEA. As detailed above, the proposed changes introduce unnecessary market,
credit, and operational risk by fundamentally altering the current execution-to-clearing workflow
for cleared swaps on SEFs. For example, eliminating the requirement for SEFs to submit executedtransactions to a CCP within a prescribed timeframe increases the likelihood that transactions will
be delayed, and potentially rejected, from clearing. It appears difficult to conclude that relaxing
the existing standards that have been successfully implemented by market participants since 2013
will promote the financial integrity of swaps executed on SEFs that are intended to be cleared.
D. The SEF Proposal Conflicts with Internationally-Harmonized Standards
The Commission’s current STP standards served as a model for the EU, which implemented
nearly identical standards as part of MiFID II. In particular, under EU regulations, (i) preexecution credit checks are required, (ii) MTFs and OTFs must submit transactions to a CCP nolater than 10 minutes after execution (and even more quickly if the transaction is executed
electronically), (iii) CCPs must accept or reject transactions within 10 seconds of receipt, (iv)
resubmission is permitted to address operational or clerical errors, and (v) bilateral breakage
agreements are not contemplated for MTF or OTF transactions that are rejected from clearing.114
By proposing to modify important elements of the current STP standards, such as eliminating
the prescribed timeframe for SEFs to submit transactions to a CCP, the SEF Proposal risks
negatively impacting the current equivalence agreement. This is because SEFs may no longer
provide the same robust execution-to-clearing operational workflows that protect EU market
participants transacting on MTFs and OTFs.
E. The SEF Proposal Fails to Satisfy a Cost-Benefit Analysis
The SEF Proposal attempts to minimize the costs associated with altering the current STP
standards by asserting that the proposed changes are “consistent with existing industry
practices.”115 This is inaccurate, and results in the Commission failing to conduct a cost-benefit
analysis that meets the statutory requirements of Section 15(a) of the CEA.
Submission Timeframes
The first significant change proposed is eliminating the requirement for SEFs to submit
transactions to a CCP no later than 10 minutes after execution, and replacing it with a qualitative“prompt, efficient, and accurate” standard. The SEF Proposal puts forward two arguments as to113

See §37.702

114

Commission Delegated Regulation (EU) 2017/582, available at: http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32017R0582&from=EN.
115

SEF Proposal at 62081.
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Section III. The SEF Proposal Introduces Material Risks to the Clearing Workflow

why this should not represent a significant change: (i) many SEFs are not meeting the current 10
minute requirement anyway,116 and (ii) market participants are still incentivized to confirm tradesin a timely manner.117 In addition, the SEF Proposal argues that more flexible STP standards may
be required given the proposed expansion of the trade execution requirement and permitted trading
protocols.118 We discuss each of these arguments below.
First, the SEF Proposal asserts that “many SEFs [. . .] have not been able to meet the timeframe when using manual affirmation hubs,” 119 but fails to provide any substantiating data
regarding current compliance rates. In our experience, current compliance rates are high, with (a)nearly all dealer-to-client on-SEF index CDS and IRS transactions submitted to clearing within
seconds, and (b) most dealer-to-dealer on-SEF index CDS and IRS transactions submitted withinapproximately 10 minutes after execution, even for voice transactions where manual affirmationis still used by the SEF. Based on our analysis, only one SEF appears to have consistent difficulties
in meeting the 10 minute standard. Instead of weakening the standards to cater for this one SEF,
and risking a reversal of the significant progress made since the STP standards were first
introduced, the Commission should require outlier SEFs to address any issues that are preventing
compliance.
These high compliance rates should not be surprising, as the current 10 minute standard was
originally proposed by the industry. Notably ISDA, representing market participants and trading
venues, represented to the Commission in July 2015 that all SEF-executed transactions (voice andelectronic) could be successfully submitted to clearing within 10 minutes by April 2016120 and
subsequently published best practice principles designed to ensure full compliance. 121 This
industry involvement in the existing STP standards also contributed to the EU adopting anequivalent 10 minute submission timeframe for all cleared swaps executed on MTFs and OTFs
under MiFID II.122
Second, while it is true that market participants have incentives to confirm trades in a timely
manner, unfortunately the clearing submission process is not in the control of any individual
market participant. Instead, the submission process only proceeds as quickly as the slowest party
involved, with a market participant bearing the risk of delays by (i) the SEF in initiating theclearing submission and (ii) its trading counterparty (for transactions that require manualaffirmation). Data relating to the execution of cleared swaps that are not subject to theCommission’s STP standards demonstrates that incentives alone are insufficient to ensure a timely
clearing submission process. This data also shows the lack of an alternative mechanism for clients116

SEF Proposal at 62022.

117

SEF Proposal at 62081.

118

SEF Proposal at 62022.

119

SEF Proposal at 62022.

120

Letter from Steven Kennedy, Global Head of Public Policy, ISDA (July 27, 2015), available at:https://www.isda.org/a/fKiDE/isdas-proposed-plan.pdf.
121

ISDA Best Practice Principles on Swaps Straight-through Processing (June 13, 2016), available at:https://www.isda.org/a/pKiDE/stp-wg-stp-general-principles-final.pdf.
122

Supra note 114.
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Section III. The SEF Proposal Introduces Material Risks to the Clearing Workflow

to demand that their liquidity providers ensure a timely clearing submission process, given thatclients need to maintain access to the limited number of liquidity providers that are available. Our
analysis found that many swaps executed off-SEF still take hours to be submitted to clearing, eventhough fewer parties are involved in the clearing submission process (e.g. just the two trading
counterparties instead of a SEF as well). Materially different submission timeframes between onSEF and off-SEF transactions are observed even when the relevant trading counterparties, clearing
members, and CCP are all identical. In fact, our analysis found that off-SEF swaps can still take
until the day after execution to successfully clear.
Third, expanding the trade execution requirement and permitted trading protocols, as proposed,
does not provide support for weakening the current STP standards for SEF trading. This is because
all clearing-mandated index CDS and IRS instruments already trade on SEFs today as Permitted
Transactions (notably on SEFs operated by IDBs), and are therefore subject to the current STP
standards.123 In addition, as detailed in Section I of this letter, many SEFs already offer a wide
range of trading protocols, including voice, work-ups, and auctions, for both Permitted
Transactions and Required Transactions. Therefore, the SEF Proposal is not expected to directly
result in either new instruments or new trading protocols being offered on SEFs that are not alreadyoffered on at least one SEF today. Current compliance rates demonstrate that the 10 minutestandard provides sufficient flexibility to be achievable across the full range of instruments andtrading protocols (voice and electronic) offered on SEFs. As further evidence, we note that MiFID
II has the same 10 minute standard even though MTFs and OTFs are given complete flexibility
regarding permitted trading protocols and support trading in the full range of clearing-mandated
instruments.
Eliminating the 10 minute standard will result in transactions taking longer to be submitted toa CCP, similar to off-SEF transactions that are not covered by the Commission’s STP standards
today. This will lead to unnecessary costs for both market participants and CCPs. Delayed
clearing submissions will introduce additional market, credit and operational risks for market
participants, as a transaction cannot be considered successfully executed until it is accepted forclearing. In addition, delayed clearing submissions will impair the ability of CCPs to predictably
monitor the flow of incoming transactions, introducing new risks that must be addressed in risk
management frameworks, including late-day submissions and associated late-day margin calls,
particularly during volatile market conditions.
In light of these costs, the SEF Proposal fails to present a compelling case for eliminating thecurrent 10 minute standard. In fact, the SEF Proposal acknowledges that “acceptance or rejection
for clearing in close to real time is crucial both for effective risk management and for the efficient
operation of trading venues.”124 We urge the Commission to further consider the practical impactof removing the 10 minute standard, and to provide related data, such as:

123

We understand that many SEFs operated by IDBs list all of the clearing-mandated index CDS and IRS for
trading.
124

SEF Proposal at 62023.
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Section III. The SEF Proposal Introduces Material Risks to the Clearing WorkflowCurrent compliance rates, broken down by instrument type;



Changes in average submission times for on-SEF transactions since the STP standards
were introduced;

Number of SEFs still using manual affirmation processes, and for which types of
instruments and trading protocols;

Number of SEFs and market participants that still have consistent difficulties incomplying with the 10 minute standard;

Average submission times for cleared off-SEF transactions that are not subject to STP
standards;

Clearing Certainty
The second significant set of changes proposed is (i) eliminating the void ab initio backstop
for on-SEF transactions that are rejected by a CCP due to operational or clerical errors and (ii)failing to maintain the prohibition on breakage agreements for SEF transactions. These changes
raise the prospect of bilateral breakage agreements being introduced for cleared swaps executedon SEFs, particularly in light of the market, credit and operational risk created by the proposed
elimination of the 10 minute clearing submission timeframe. Introducing breakage agreements
would impose the following unnecessary costs on market participants, none of which appear tohave been considered in the SEF Proposal:
Liquidity disruption. In light of the current STP standards, bilateral documentation has
not been put in place between trading counterparties on SEFs for cleared swaps. To theextent market participants considered breakage agreements necessary in light of the risks
introduced by the proposed STP changes, there could be material disruption to liquidity
provision and trading activity while these agreements are being negotiated between eachpair of trading counterparties.



Reduced access to counterparties. One the main benefits of central clearing is theelimination of bilateral counterparty credit risk and bilateral trading documentation,
which enables clients to access a broader range of counterparties.125 Academic research
has shown that central clearing and SEF trading dramatically increased the number ofliquidity providers that clients transact with for swaps. 126 Introducing breakage
agreements for cleared swaps executed on SEFs undermines this benefit, impairing theease of trading cleared swaps and limiting client access to new sources of liquidity.

125

See, e.g., Incentives to centrally clear over-the-counter (OTC) derivatives: A post-implementation evaluation of
the effects of the G20 financial regulatory reforms (Nov. 19, 2018) at Figure D.3 (page 26), available at:
http://www.fsb.org/wp-content/uploads/R191118-1-1.pdf.
126

Supra note 32 at page 26.
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Section III. The SEF Proposal Introduces Material Risks to the Clearing Workflow
Decreased competition. As detailed above, the introduction of breakage agreements forcleared swaps executed on SEFs creates significant hurdles that limit client access to new
liquidity providers, including counterparty credit assessments and the negotiation ofbilateral documentation. The re-introduction of bilateral counterparty credit risk forcleared swaps also creates a pretext for SEFs to implement discriminatory access criteria,such as limiting access to self-clearing members of a CCP.



Additional complexity. The void ab initio backstop establishes a consistent, marketwide standard in the event a SEF-executed transaction cannot be successfully cleared.
By eliminating this backstop for transactions rejected due to operational or clerical errors
and allowing each SEF to establish bespoke error trade policies, the SEF Proposal
significantly increases complexity for market participants, as the impact of a clearing
rejection may be different from one SEF to another. This lack of consistent standards
may create confusion and negatively impact liquidity, particularly in volatile market
conditions.



Restrictions on innovation. Certain trading protocols, such as anonymous order booktrading, cannot operate as intended if bilateral documentation is required between trading
counterparties. Removing the void ab initio backstop and re-introducing bilateralcounterparty credit risk for cleared swaps impairs the ability of SEFs to innovate withrespect to trading protocols, which appears to be contrary to other aspects of the SEF
Proposal.

In light of the costs detailed above, the Commission must present a compelling case formodifying the current STP standards. However, the SEF Proposal fails to provide any evidence
to suggest that the current STP standards are not operating in an effective and beneficial manner
for market participants. To the contrary, the current STP standards have dramatically reduced
market, credit, and operational risk when trading cleared swaps on SEFs and have resulted in arobust execution-to-clearing workflow where clearing rejections are extremely rare. In fact, wehave been unable to identify a single transaction executed on-SEF in 2018 by either Citadel or
Citadel Securities that was declared void ab initio. We urge the Commission to conduct a more
fulsome cost-benefit analysis, including providing market-wide statistics on the overall percentageof transactions that have been declared void ab initio, before modifying STP standards that havebeen successfully implemented by the market since 2013 and have served as a model for otherjurisdictions.
F. Suggested Alternatives
Instead of proposing modifications that would introduce unnecessary risks and costs for market
participants, the Commission should formally codify the current STP standards, including (i) the
additional STP guidance,127 (ii) the no-action letter setting forth the 10 minute clearing submission

127

Supra note 104.
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Section III. The SEF Proposal Introduces Material Risks to the Clearing Workflow
timeframe,128 (iii) the no-action letter permitting resubmissions to correct operational or clericalerrors,129 and (iv) the prohibition on breakage agreements for SEF transactions.130 As is the casetoday, these standards should apply to all cleared swaps executed on or pursuant to the rules of
SEFs (including block transactions, consistent with current market practices131), regardless of the
trading protocol employed, which CCP is clearing the transaction, and whether the transaction is
subject to the clearing mandate (or is voluntarily cleared).132
In codifying the ability of SEFs to allow resubmissions to correct operational or clerical errors,
we support providing SEFs with additional flexibility to determine the best procedures tostreamline the error correction and resubmission process. For example, SEFs should not be
required to make an affirmative finding that the trade resulted from an error, and should bepermitted to allow the trading counterparties to quickly initiate the error correction process.
However, all SEFs should remain subject to the same one hour deadline to effect a resubmission
and the void ab initio backstop should remain applicable to the extent a transaction cannot be
successfully cleared.
In addition to codifying the current STP standards for SEF transactions, we encourage theCommission to consider similar standards for off-SEF trading activity that are designed to improve
market functioning and efficiency. For example, in the EU, transactions executed away fromtrading venues are required to be submitted to clearing within 30 minutes of execution.133

Supra note 103. In doing so, the Commission should retain the overarching standard that “trades should be
accepted or rejected for clearing as soon as technologically practicable as if fully automated systems were used.”
128

129

Supra note 106.

130

Supra note 108.

131

See CFTC Letter No. 17-60 (Nov. 14, 2017), available at: https://www.cftc.gov/sites/default/files/csl/pdfs/17/1760.pdf, which we recommend codifying.
132

A more in-depth analysis of current data, as suggested herein, may demonstrate that certain targeted exceptions
are warranted, such as for risk mitigation services offered by SEFs for FRAs.
133

Supra note 114.
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Section IV. Other Topics

IV. Other Topics
A. Scope of the Trade Execution Requirement(i)

Instruments

Both Citadel and Citadel Securities agree with the Commission that the current SEF-driven
MAT determination process has proven to be suboptimal. Additional instruments should beconsidered for mandatory SEF trading, such as fixed-to-float swaps in currencies other than
USD, EUR, or GBP and certain commonly traded forward-starting swaps (e.g. 1Y1Y and
5Y5Y). However, the proposal to eliminate the MAT process entirely risks bringing into scopecustom and bespoke instruments, particularly in the interest rate asset class, that may not wellsuited for mandated multilateral and pre-trade transparent execution on SEFs. In addition, theproposal may discourage further expansions of the clearing obligation, even though certain FX
non-deliverable forwards and additional CDS indices are being cleared in material volumes.
Instead of relaxing minimum standards for SEF execution in order to cater for these custom
and bespoke instruments, we recommend that the Commission revise the MAT process such thatit has a central role in setting the appropriate scope of the trade execution requirement. We notethat this approach is consistent with the process in the EU under MiFID II and therecommendations made by the U.S. Department of the Treasury in its 2017 Capital Markets
Report.134
We also agree with the Commission that trading activity in package transactions containing
a component that is subject to the trade execution requirement should continue to transition onto
SEFs.135 In this context, we recommend that the Commission engage with the CME to amend
CME Rule 538 so as to allow invoice spread packages containing an interest rate swap and aninterest rate future to trade on SEFs. Currently, CME Rule 538 prevents a swap that is tradedon, or subject to the rules of, a SEF from serving as the related position component of an
Exchange for Risk or Exchange of Option for Option transaction. In our view, there is not aclear legal or operational justification for this limitation, and the conflict between CME Rule 538
and the trade execution requirement must be resolved in order to facilitate the transition of
invoice spread packages onto SEFs.
(ii)

Market Participants

While we support the proposal to codify an exemption from the trade execution requirement
for transactions where an exemption from the clearing obligation applies, this exemption should
be limited to the currently available exemptions set forth in part 50 (Clearing Requirement andRelated Rules).136 The Commission should refrain from pre-emptively granting exemptions for

134

Supra note 3.

135

See SEF Proposal at 62039.

136

See SEF Proposal at 62038.
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Section IV. Other Topics

potential future modifications of part 50, as any such future modifications should be evaluatedon a case-by-case basis pursuant to CEA Section 4(c).
In addition, market participants should be required to actually elect an exemption from theclearing obligation in order to be eligible for the corresponding exemption from the trade
execution requirement.137(iii) Implementation Timing
To the extent the scope of the trade execution requirement is expanded, it is important thatliquidity in those instruments transitions onto SEFs in an efficient manner. In our view, phasingin an expansion to the trade execution requirement by counterparty type introduces unnecessary
complexity for market participants. The initial implementation of the trade execution
requirement in 2014 proceeded quite smoothly with all market participants being subject to thesame compliance date, even though everyone was connecting to SEFs for the first time. The
SEF Proposal has failed to justify altering this previous approach.
B. Pre-Execution Communications and Block Transactions
Both Citadel and Citadel Securities strongly agree with the Commission continuing to prohibit
pre-arranged trading to ensure that competitive execution occurs on SEFs. 138 However, theproposed blanket prohibition on any off-SEF pre-execution communications may be problematic,
particularly with respect to the negotiation of block transactions. Dealer-to-client SEFs do notcurrently offer voice functionality, and it appears unlikely that individual SEFs would installdedicated phones, as suggested in the SEF Proposal.139 Therefore, clients would be required toalter current trading practices in order to comply with the prohibition on pre-execution
communications, which could make the negotiation of block transactions in particular more costly.
C. Improving SEF Disclosures
Both Citadel and Citadel Securities support the Commission’s efforts to increase the level oftransparency provided by SEFs with respect to trading protocols and the use of discretion. 140 In
addition, we believe SEFs should be required to publicly disclose (i) all fees imposed on members,
including for connectivity or API access, and (ii) the details of any market maker or trading
incentive programs offered, including the eligibility criteria and the discounts or rebates provided.
This type of disclosure will ensure a baseline level of transparency for market participants.

*

*

137

See SEF Proposal at 62040.

138

See SEF Proposal at 62043.

139

SEF Proposal at 62061.

140

See SEF Proposal at 61982.

*

*

*

*

*

*

*

*

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Section IV. Other Topics

We thank the Commission for considering our comments on the SEF Proposal. Please feel
free to call the undersigned at (646) 403-8200 with any questions regarding these comments.
Respectfully,/s/ Stephen John Berger
Managing Director
Global Head of Government & Regulatory Policy

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