US regulator the Securities and Exchange Commission (SEC) has laid out the requirements for new markets that will trade over-the-counter (OTC) derivatives, but has included key differences to similar proposals by the Commodity Futures Trading Commission (CFTC).
The need for tighter regulation of the over-the-counter derivatives market became a key priority for policy makers following the fallout from the financial crisis in 2008. The US has mandated clearing and on-exchange trading of OTC contracts in the Dodd-Frank Financial Reform and Consumer Protection Act and has delegated responsibility for deciding the final rules to the CFTC and SEC.
The SEC will deal with security-based swaps, which it defines as derivatives based on a single security, loan, narrow-based group or index of securities or event relating to a single issuer of securities in a narrow based security index. By comparison the CFTC will cover swaps based on interest rates, commodities and currencies.
The SEC has proposed a number of core principles and attributes for trading venues that deal in security-based swaps and derivatives, such as credit default swaps, also known as swap execution facilities (SEFs). A SEF is defined by the SEC as a type of “system or platform that allows more than one participant to interact with the trading interest of more than one other participant on the system or platform”.
Similar to proposals made by the CFTC, the SEC has said SEFs could take the form of a request-for-quote (RFQ) system – where participants define the contract they require and request a price from a number of participants – or a limit order book system.
But unlike the CFTC, which said that participants using RFQ systems must source quotes from at least five liquidity providers, the SEC has said there is no limit on the number of quotes required. Under the SEC rules, those requesting quotes would be able to specify the number of preferred quotes they receive.
These differences will give buy-side firms more flexibility when trading those instruments covered by the SEC compared to those under the rule of the CFTC.
The SEC will seek public comment on its proposals until 4 April 2011 after which it will decide whether to adopt the proposal or modify it.