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Discussion Topics Concerning Swap Execution Facilities (SEFs) under the Dodd-Frank Act (DFA)

The SEF definition as well as the operative provisions of the DFA specify that SEFs perform three discrete functions – they provide the ecute”; and (iii) “trade process” the swaps.1 Because the legislator used these specific and distinct terms, it appears that the legislative 

and distinct functions of the SEFs, which are accordingly grouped into three categories described below: (a) Category I – the “Trading 

the “Execution Facility SEF” (with three subcategories A, B, and C); and (c) Category III – the “Trade Processing / Confirmation FaFacility SEF). It also appears that the legislative intent was to require that all transactions benefit from legal confirmation, processing, 

tion of all swaps, aggregate reporting and other services provided by Category III SEFs. It is possible that the same SEF entity would band III SEF or as either of these categories taken separately. 

Categories of SEFs 

Applicable Provisions in the DFA and the CEA 

Functionality Liquidity / 

Frequency of Trades 

Regulation / Comments Existing Examples Reg

Req

Category I “Trading Facility” SEF 

- “Multiple participants have the ability to execute or trade agreements, contracts, or transactions... through the interaction of multiple bids or multiple offers within a system with a predetermined non-discretionary automated trade matching and execution algorithm” ; (CEA 1a(34)(A)(ii))2- Makes “available for trading any swap” (DFA, CEA 5(h)(b)(1)(A))3

Exchange-type algorithmic matching and an open order book of trades 

Liquidity High, Multiple bids / offers 

SEF Definition4 and SEF operative provisions.5SEF definition specifically includes “trading facilities”. Regardless of the method of trading and execution, all trades must be confirmed on Category III SEF (or by Category I SEF with Category III SEF functionality). 

Many existing exempt commercial markets (ECMs) – trading facilities 

ExcFor mosble ciplManswatics 

1 See suggested definitions for these terms provided at the end of this document in Explanatory Notes. 2 See Commodity Exchange Act (CEA) Sec. 1a(34)(A)(ii) – numbering before the amendment by the DFA. 3 CEA after amendment by the DFA. Also, see B. Lincoln colloquy to the Senate below. 4 DFA §721 “(50) SWAP EXECUTION FACILITY.-The term 'swap execution facility' means a trading system or platform in which multiple particip

swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce, including any tr

execution of swaps between persons; and (B) is not a designated contract market.” 

5 DFA §733. “5h. SWAP EXECUTION FACILITIES. (a) REGISTRATION.- (1) IN GENERAL.-No person may operate a facility for the trading or p

registered as a swap execution facility or as a designated contract market under this section. (2) DUAL REGISTRATION.- Any person that is register

this section shall register with the Commission regardless of whether the person also is registered with the Securities and Exchange Commission as a sAND TRADE PROCESSING.- (1) IN GENERAL.-Except as specified in paragraph (2), a swap execution facility that is registered under subsection (any swap; and (B) facilitate trade processing of any swap. (2) AGRICULTURAL SWAPs.-A swap execution facility may not list for trading or confir

cultural commodity (as defined by the Commission) except pursuant to a rule or regulation of the Commission allowing the swap under such terms an

prescribe. (c) IDENTIFICATION OF FACILITY USED TO TRADE SWAPS BY CONTRACT MARKETS.- A board of trade that operates a contracboard of trade also operates a swap execution facility and uses the same electronic trade execution system for listing and executing trades of swaps on swap execution facility, identify whether the electronic trading of such swaps is taking place on or through the contract market or the swap execution f

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Categories of SEFs 

Applicable Provisions in the DFA and the CEA 

Functionality Liquidity / 

Frequency of Trades 

Regulation / Comments Existing Ex- Reg

amples Req

Category II Execution Facility SEF (with 3 subcategories A, B, and C) 

- “Multiple participants have the ability to execute or trade agreements, contracts, or transactions...by accepting bids of offers made by other participants that are open to multiple participants in the facility or system” (CEA . 1a(34)(A)(i)) 

Facility where trades are bindingwhen executed on the platform, but no algorithmic matching 

Liquidity High, Multiple bids / offers 

Meets the definition of a “trading facility” in the CEA (first prong of the definition). Regardless of the method of execution, all trades must be confirmed on Category III SEF (or by Category II SEF with Category III SEF functionality). 

Execution facility 

(A) ity. MoprinalgoappManswatics 

- “trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce ... that- - facilitates the execution of swaps between persons” (DFA, CEA 1a(50)) - Makes “available for trading any swap” (DFA, CEA 5(h)(b)(1)(A)).6

Implies only multiple to multipletrading and execution is included 

Liquidity High, Multiple bids / offers 

SEF definition in the DFA that describes SEFs that are other than “trading facilities”. It is possible to demonstrate multiple-to-multiple participation on some (request for quote) RFQ platforms. 

RFQ, interdealer platforms with active participation of multiple participants will qualify 

“have the ability” and “facilitates” may imply that 1-to-1, 1-to-many, illiquid RFQ, voice brokerage facilities may be included 

Liquidity Low, Very few or no multiple bids / offers 

Some non-multiple to multiple facilities will qualify. The definition of the SEF clearly shows legislative intent to include in the definition some facilities in addition to simply “trading facilities”; otherwise legislator would have simply merged the SEF definition with the DCM (exchange – trading facility) definition. 

Illiquid RFQ facility; voice brokerage facility; intradealer platforms 

(B) FacSomply. Manprodprov(i) t(ii) tiple(iii) 

Securities and Exchange Commission and Commodity Futures Trading Commission may promulgate rules defining the universe of swaps that can be These rules shall take into account the price and nonprice requirements of the counterparties to a swap and the goal of this section as set forth in subse

required to be executed through a swap execution facility as defined in paragraph (1), such trades may be executed through any other available means 

ties and Exchange Commission and Commodity Futures Trading Commission shall update these rules as necessary to account for technological and otSTRUCTION.-The goal of this section is to promote the trading of swaps on swap execution facilities and to promote pre-trade price transparency in t

6 In connection with this phrase, note that Senate Agriculture Committee Chairman B. Lincoln in her colloquy stated: “the CFTC should take a practic

proach...whether, as a practical matter, it is in fact possible to trade a swap on the facility... should consider... whether there is a minimum amount of be traded on the facility, without a minimum amount of liquidity to make trade possible, should not be sufficient to trigger the Trade Execution Requir

gressional Record – S5919, July 15, 2010). 

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Categories of SEFs 

Applicable Provisions in the DFA and the CEA 

Functionality Liquidity / 

Frequency of Trades 

Regulation / Comments Existing Ex- Reg

amples Req

met 

 “have the ability” and “facilitates” implies that negotiation of nonbinding trades is possible if “facilitates” execution of swaps 

Liquidity Low, No multiple bids / offers 

Not all of the core principles will apply. This type of facility allows participants to negotiate and execute a binding trade on the facility. Regardless of the method of execution, all trades must be confirmed on Category III SEF (or by Category II SEF with Category III SEF functionality). 

Negotiation facility; bulletin board-type facility 

(C) Somply. Manprodprov(i) t(ii) tiple(iii) met 

Category III Trade Processing / Confirmation Facility SEF 

- “No person may operate a facility for the trading or processing of swaps unless the facility is registered as a swap execution facility... under this section.” (DFA, CEA 5(h)(a)(1)). - “facilitate trade processing of any swap” (DFA, CEA 5(h)(b)(1)(B)). 

Electronic screen based trade processing and confirmation process. Trading (and execution) functionality is captured by Categories I and II. No algorithmically matched or executed trades occur on the platform; multiple is likely satisfied by open access to the platform; block trades 

High or Low, or None (e.g., only two participants in the market) Can accommodate trade processing of every possibletransaction regardless of how it is traded, executed, negotiated 

This provision is much broader than the definition of the SEF because mandates any entitytrading or processing swaps to register as a SEF. Note, the definition does not say that a SEF must register, but states instead that any entity that performs trading or trade processing functions must register as a SEF §733. Will depend on how the CFTC further defines “trading or processing of swaps” (see suggested definitions below). Such facility need not both trade and process, merely trade 

Electronic trade processing and confirmation facilities 

TracilitSomply. Manprodprov(i) t(ii) tiple(iii) met To fbusjor concate

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Categories of SEFs 

Applicable Provisions in the DFA and the CEA 

Functionality Liquidity / 

Frequency of Trades 

Regulation / Comments Existing Ex- Reg

amples Req

are possible and other noncompetitive forms of execution (analogy to EFP, EFS, give-ups, etc.). Provides trade information capture, legal confirmation, audit trails, etc. 

or cleared. processing is sufficient to be 

subject to registration if this SEF intends to fulfill the mandatory trading requirement in the DFA on this facility. 

tradtion CatconSEF quirtion

Explanatory Notes: “Trading” – The term “trading” of swaps on a swap execution facility means the interaction of multiple bids or 

tem with a predetermined non-discretionary automated trade matching and execution algorithm. “Execution” – The term “execution” of swaps on a swap execution facility means accepting bids or offers made open to multiple participants in the facility or system. “Trade processing” – The term “processing” or “trade processing” of swaps on a swap execution facility meanaffirmation or any other electronically recordable method of interstate communication used by two participants swap; or (ii) electronic negotiation of the terms of and entering into bilateral transactions in swaps as a result of by participants and not as a result of trading or execution of swaps; or (iii) posting on the swap execution facility ecuted swaps entered into by two participants by means of block trades, give ups, exchanges of risk, or any other or non-competitive execution authorized by the Commission. “Make available for trading” – The phrase “make available for trading” means: (i) making the swap execution by participants of an instrument that the CFTC has determined is subject to the trading requirement in section 2(

7 See DFA §731; CEA §4s(i) as amended by the DFA. To carry out documentation and recordkeeping requirements of the DFA, the CFTC should con

swap trades, regardless of whether they are cleared or not, be documented, trade processed, confirmed or affirmed on SEFs of Category III (unless theon SEFs of Categories I and II via the functionalities of Category III). 

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execution facility can demonstrate sufficient liquidity in the instrument consistent with prevailing market practicecution facility available for execution by participants of an instrument that the CFTC has determined is subject section 2(h)(8) of the Act; and (iii) trade processing of such swap in the event that trading or execution is not poscient market liquidity for such swap, a small number of participants trading or executing such swap, or a high de

swap. The phrase “facilitates the execution of swaps between persons” shall have the same meaning. Additional Requirement to Consider (under DFA §731 and CEA §4s(i) – Documentation Standards for Swap 

ticipants): To ensure that swap dealers and major swap participants not only report their open positions to the swaps data re

sion, but also maintain an audit trail of all their trades, the swap dealers and major swap participants must be obli

firm their swap trades to maintain detailed electronic audit trails of all their transactions in swaps. The requireme

tion” of swaps will ensure that swap execution facilities and the designated contract markets will maintain their a

confirmations; particularly, if the SEFs and DCMs are required to perform all the confirmation, affirmation and dformed by the Category III SEFs. However those swaps that are not traded or executed on the SEFs or the DCMcleared – must be trade processed to ensure that they are properly confirmed and that a detailed audit trail is crea“It shall be unlawful for a swap dealer or a major swap participant to enter into swaps unless such swap dealer trades, executes, or trade processes the swap on a swap execution facility.”. 

8 It is expected that the CFTC rule-making will require two components of “make available for trading” for Category I SEFs: (1) the C

ticular instrument has appropriate characteristics (liquidity, standardization, etc.) such that it may be traded on a Category I SEF, and (

the instrument for trading (with “offers for trading” being defined to require specific liquidity metrics, e.g., minimum number of bids/otions should not require a particular manner of trading or execution that cannot be achieved, thereby actually eliminating liquidity that e