SEFs are registered trading exchanges that operate under the oversight of the CFTC. Under CEA Section 1a(50), a SEF is a: 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, including any trading facility, that (A) facilitates the execution of swaps between persons; and (B) is not a designated contract market.
SEFs are subject to CFTC regulatory oversight pursuant to Section 5h of the CEA (adopted under the Dodd-Frank Act) and are a type of SRO that must register with the CFTC. The CFTC has explained that the SEF rules and regulations are intended to “promote the trading of swaps on SEFs and to promote pre-trade price transparency in the swaps market.” Requirements for registration as a SEF are set forth in Part 37 of the CFTC’s regulations. As an SRO, a SEF must, among other things, enforce ongoing compliance with its rulebook from SEF participants. In accordance with the CEA and CFTC regulations, only eligible contract participants (“ECPs”) are permitted to trade on SEFs. ECPs, as further defined in Section 1(a)(18) of the CEA, are sophisticated or institutional market participants.
Registered SEFs must offer central limit order book (“CLOB”) trading functionality, which the CFTC refers to as “minimum trading functionality.” A CLOB provides participants with the ability to enter, observe, and transact against multiple bids and offers available on the platform. SEFs must also comply with Core Principles established in the CEA and with applicable CFTC regulations.
The CFTC has the authority to determine that certain swaps must be cleared unless an exception or exemption is available, which is generally referred to as “mandatory clearing.” For swaps subject to mandatory clearing, the CFTC also has the authority to determine that the swaps must be executed on or pursuant to the rules of a DCM or SEF, which is generally referred to as “mandatory trading” or the “trade execution requirement.” If a swap is subject to mandatory trading, then absent an exception or exemption, the swap must be executed on a SEF via CLOB or a request for quote system that operates in conjunction with a CLOB. The request for quote must be disseminated to at least three unaffiliated market participants
Although a SEF must offer CLOB trading functionality, that does not mean that all swaps must be executed via the CLOB. For swaps that are not subject to mandatory trading, the swap may be executed via any means of interstate commerce. Furthermore, for swaps that are subject to mandatory trading, as noted above, such swaps may be executed (i) via a CLOB, (ii) via a request for quote submitted to at least three unaffiliated participants, or (iii) as a block trade pursuant to the rules of the SEF. Alternatively, a person may rely upon an exception or exemption to the mandatory clearing or mandatory trading requirements.