The SEC wants to regulate an obscure product known as a swap execution facility. Here’s why

The Securities and Change Fee has voted unanimously to suggest a rule for the registration and regulation of security-based swap execution services.

A swap execution facility, or SEF, is an digital buying and selling platform that permits members to purchase and promote swaps. A swap is a contract by way of which two events trade the money flows or liabilities from two totally different monetary devices.  

Swaps are a really giant a part of the derivatives market, and they’re used to handle danger. For instance, one of many largest markets is for rate of interest swaps. These are contracts through which one stream of future curiosity funds is exchanged for one more.

You may as well use swaps to handle market danger.  

There are actually trillions of {dollars} in derivatives and swaps available in the market. Below the Dodd-Frank Act, the Commodity Futures Buying and selling Fee, or the CFTC, regulates futures swaps, together with rate of interest swaps, and the swap execution services. 

Previous to this, it was troublesome to get a deal with across the dimension of the buying and selling — and even what was being traded. This created considerations about systemic danger, particularly after the mortgage market blew up within the Nice Monetary Disaster. 

These futures-based swap execution services put these swap futures on a platform that may very well be monitored and controlled by the CFTC. One essential participant was the top of the CFTC on the time: Gary Gensler.

Certainly, Gensler is now accountable for the SEC. The company is making an attempt to promulgate comparable guidelines that might govern securities-based swaps.

There’s an equal concern that fairness swaps could also be a systemic danger. 

Bear in mind, a lot of the issue with Archegos Capital Administration in 2021 concerned a sort of instrument referred to as a “whole return swap.” In that case, there was a contract that allowed one occasion to make funds based mostly on a set charge and one other occasion to make funds based mostly on the whole return of an underlying asset, on this case largely ViacomCBS inventory. 

Archegos acquired revenue generated by the property, and the agency was not required to reveal the holding to regulatory authorities or different counterparties. When ViacomCBS’ inventory value started dropping, Archegos (which had been utilizing leverage) acquired margin calls it could not meet, which led to an enormous fireplace sale of property. 

The SEC’s proposed guidelines would require platforms that execute trades of security-based swaps to register with the regulatory company to extend transparency.