Final CFTC rules on swap execution facilities (SEFs) took effect on October 2, 2013 despite widespread call from market participants and global regulators to delay implementation. SEFs are electronic swaps trading platforms introduced by Title VII of the Dodd-Frank Act that allow market participants to enter into derivatives transactions with one another, bypassing the large banks that have traditionally been the gatekeepers to these markets. SEFs are a major component of Dodd-Frank derivatives reform because they have the potential to permanently change the global swap-trading landscape and the manner in which derivatives are transacted. However, market participants claim they are not ready for the SEF era, and many have been critical of the final rules. Though the CFTC elected not to delay the October 2 effective date of the SEF rules, the CFTC has issued a number of no-action letters primarily addressing certain operational and logistical concerns related to the SEF rules (see SEF No-action Relief).

The final SEF rules are designed to:

Among other things, the final SEF rules provide for:

Now that the final rules, adopted by the CFTC on May 16, 2013 are effective, it is anticipated that SEFs will begin to proliferate. Regulators hope the proliferation of SEFs will eliminate some of the barriers to entry into the swaps market for mid-market participants and commercial end users while introducing transparency and additional liquidity into the swaps markets. The final SEF rules attempt to shift the market from a bilateral one to more of a public exchange-style market through the use of SEFs.

Registered SEFs, along with designated contract markets (DCMs), which are larger, more traditional derivatives exchanges, qualify as registered exchanges for purposes of satisfying the mandatory Title VII swap exchange trading requirement for any swap entered into on that SEF that is subject to that requirement (see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Swap Clearing and Exchange Trading under Title VII). However, registered SEFs must adhere to the final SEF rules regardless of whether they are offering for trade:

Note that although October 2, 2013 is characterized as a "deadline," it was simply the first date that firms that have applied to the CFTC to operate as SEFs and have been "temporarily" approved must adhere to the rules. Firms may continue to have their electronic swaps trading platforms approved as SEFs, which can begin to operate on any future date. October 2 was simply the earliest date that registered SEFs were required to begin compliance with the final SEF rules, with the exception of rules for which the CFTC issued no-action relief (see SEF No-action Relief).

Market participants and global regulators have expressed concern that:

In addition to these criticisms, on a broader scale, market reaction to the final SEF rules has been mixed because the rules:

Financial industry groups such as SIFMA, as well as large brokers and financial institutions active in the swaps markets, objected to many provisions included in the final rules. They warned that they would result in increased trading costs, decreased liquidity and unnecessary regulation.

However, by reducing the required RFQs from five to three and continuing to allow bilateral negotiation of swap terms by telephone, some argue that regulators are allowing the largest financial institutions to continue exclusive swaps within their own ranks.

For details on other implications of the final SEF rules, including implications for the use of standardized ISDA swap documentation for bilateral derivatives transactions and for derivatives lawyers, see Legal Update, Final Dodd-Frank Swap Execution Facility (SEF) Rules: Good for the Market, But for Lawyers…?.

The CFTC has issued the following new no-action letters providing limited relief from certain of the final SEF rules:

In order to register and establish a SEF, an entity must comply with Section 37 of the CFTC Regulations, which consists of general regulations and 15 core principles that a SEF is required to adopt. The general regulations, contained in Part A of Section 37, include, among other things, registration requirements (including minimum functionality), the scope of the rules and procedures for listing derivatives. Entities that want to register as SEFs need not be swap dealers, but they must have sufficient financial resources, defined as resources sufficient to cover the operating costs of the SEF for one year. Entities have reasonable discretion in determining the methodology used to calculate operating costs of the SEF and must determine their fiscal eligibility on a rolling basis, calculated quarterly.

Parts B through P of Section 37 include the 15 core principles that registered SEFs must adopt. These principles require that the SEF will, among other things:

Entities that wish to act as both SEFs and DCMs must register as each under the requirements of Section 38 for DCMs and Section 37 for SEFs, and must comply with the core principles of both on an ongoing basis.

The CFTC has provided Appendix A, Form SEF to aid in SEF registration.

The SEC has reportedly informally cautioned market participants about entering into transactions on SEFs that could ultimately be classified as security-based swaps (SBS), which fall under the SEC's jurisdiction. The SEC is concerned that the CFTC's SEF rules may ultimately not align with its final trading-platform rules for SBS. Any such trades could ultimately be deemed to violate SEC rules for SBS trading, which have yet to be finalized.