October 2, 2013

The first backward step | SEF Oct 2 – two FX Options SEFs pull the plug on US persons

Following my post last week, Risk has reported (subs. required) that two FX options ECNs (Digital Vega and SurfacExchange) have announced they will not comply with SEF registration on October 2 and therefore turn off their US customers from that date.

I'm guessing even the leading FX ECNs / their current participants are struggling to be ready and we'll see a net shift of US persons FX options / NDFs trading volume from would be SEFs either back to voice, or to single dealer platforms or to ECN trading via an offshore affiliate.

Sticking point

One interesting sticking point is a controversy over whether SEFs have to offer both RFQ and CLOB protocols as some previously assumed that one or the other was OK.  Building a CLOB when you were assuming RFQ only was ok is a significant and time consuming reengineering effort as well as an effort to build market maker liquidity support which is no doubt challenging even some of the incumbent would-be SEFs.   For FX options specifically, a given FX options series have more and less liquid strike and maturity combinations by their nature and it is not clear whether CLOB is required for all or only for the more liquid combinations.

Impact of October 2 deadline

This is the first concrete news for FX ECNs of what will likely be a temporary shift between October 2 and the made available to trade mandate coming in late Q4 2013 / Q1 2014 of US persons no longer having access to some SEFs either because the SEF or they are not ready for the "surprise" permitted transactions provision in "footnote 88" of the SEF rules.  This means that until made available to trade mandates hit, US persons shut out from FX options SEFs – either by the SEF's or their own lack of readiness – can do one of the following:

  1. Use another SEF that is ready (if any FX SEFs made it)
  2. Regress to voice execution
  3. Use a single dealer platform (not caught by the October deadline as they are not multi-to-multi platforms)
  4. Continue to trade on non-SEF compliant ECNs (via affiliated offshore entities – perhaps also benefiting from the ET exemptive relief which expires in December)

Possible Outcome

If the CFTC is in luck, the leading FX OTC ECNs may be ready to pick up the slack at the fringes provided participants are also ready.   If so footnote 88 may in effect promote early SEF liquidity consolidation in the FX asset class – perhaps this is the CFTC's intent?

Realistically, even the leading FX OTC ECNs were likely wrong-footed by footnote 88 and had long planned to sit back and wait for the FX clearing mandate and even if they are ready some of the current participants may not be ready.   It seems likely therefore that single dealer and voice channels will get at least a short term FX options / NDFs volume boost for now.

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