It’s late on a Wednesday afternoon in early summer, and
Sunil Hirani has liquidity on his mind. “We’ve been
doing record volumes in the past few months,” he says of
trueEX, the swap execution facility (SEF) he co-founded in
2011. “Would you like a margarita?”
There’s a party in the reception area of truEx’s
headquarters in New York’s Flatiron District, and the
bartender has started preparing frozen margaritas. Hirani, 48,
is dressed in an electric blue suit with no tie, a look that
might best be termed fintech CEO business casual. He says:
“I met Jeb Bush today. He was kind of flat.” Then,
without waiting for agreement, he adds, “That’s off
the record!” A blur of bonhomie, jokes, self-promotion and
theatrically conspiratorial, not-for-publication asides follow.
Hirani is in his element. Brandishing margaritas, he bounces
around dispensing refreshment to his thirsty-looking employees.
Meanwhile, in smaller rooms off to the side of the party, he
has, he says, “three meetings going at once.”
If Hirani, who emigrated to the U.S. from India at the age
of 10 and got his start on Wall Street after completing an MBA
at Northwestern University, seems adept at keeping many people
happy at once, it’s because he’s constructed a career
out of the act. He had already worked on the swaps-trading
desks of Bankers Trust and Deutsche Bank when he founded
Creditex in the late 1990s. At Creditex he built the first
brokerage platform for the electronic trading of
credit default swaps. At the time, the interdealer broker
(IDB) world was dominated by voice trading, with dealer banks
calling around to various brokerage houses in search of the
best price. The IDB industry was the very definition of clubby,
closed, relationship-based finance, because best execution
relied on personal access to the brokers with the best prices.
Executing trades electronically — on an open, transparent
and potentially anonymous platform — was antithetical to
the business model of the industry.
Creditex was sold to Atlanta-based
Intercontinental Exchange in 2008 for $625 million. But
getting Creditex off the ground was no easy task. Hirani needed
the drive of an entrepreneur and the tact of a diplomat to
cultivate the different sides of a complex industry and
convince participants that electronic trading was the future of
swaps, the derivatives used in global financial markets to
hedge and manage risk. He says the experience taught him two
things: “Make friends rather than enemies. Build bridges
rather than burn bridges.”
At trueEX, Hirani has taken bridge building to
a new level. Written off by many in the industry when SEFs
— a new breed of electronic trading venue brought into
being by postcrisis financial reform — began live trading
18 months ago, 45-person trueEX has succeeded in carving a
niche for itself in markets dominated by much larger companies,
including
Bloomberg, Tradeweb Markets and legacy IDBs such as ICAP,
Cie. Financière Tradition and Tullett Prebon. To
succeed, Hirani has had to connect different sets of market
participants — the buy side, dealer banks, clearinghouses
— with disparate agendas and little appetite for change.
Today, trueEX accounts for 5.7 percent of overall swaps-trading
volume on SEFs; on good days it handles as much as 38 percent
of trading in the market segment that links dealers directly to
the buy side, according to Clarus Financial Technology, a
Chicago- and London-based financial consulting firm with
transaction data that is widely considered authoritative by the
industry.
This is an impressive achievement: 24 companies applied to
be SEFs when the U.S. Commodity Futures Trading Commission
(CFTC), the agency responsible for regulating derivatives, put
the final touches on new swaps-trading rules in 2013. Barely a
dozen survive today, and trueEX is the only one whose sole
corporate raison d’être is to be a SEF. The
facilities operated by Bloomberg and Tradeweb, whose majority
shareholder is Thomson Reuters, are connected to giant
financial data firms, and IDB-operated SEFs are new business
units within legacy brokerage houses. “It hasn’t been
easy, and on-SEF trading has been much slower than many of us
in the industry thought it would be,” Hirani admits.
“But it’s starting to pick up.”
If part of the objective of postcrisis swaps reform was to
give market participants a choice over where they executed
their trades, the ability of a small, independent technology
start-up such as trueEX to secure a foothold in a marketplace
of Goliaths — a small success, to be sure, but a
significant one — suggests those reforms may be
functioning as designed. But it remains to be seen whether
Hirani and trueEX can go on to help shepherd the market toward
a future in which swaps trade like equities, in an open,
electronic, automatic and anonymous manner.
Swaps reform was a signature project of the
Dodd-Frank Wall Street Reform and Consumer Protection Act,
which President Barack Obama signed into law five years ago
today. The opacity and complex lines of collateral and
counterparty risk associated with the over-the-counter swaps
market were widely seen by lawmakers as a chief culprit in the
meltdown of American International Group amid the global
financial crisis of 2008–’09. In passing Dodd-Frank,
Congress aimed to bring accountability and transparency to the
derivatives market by shifting swaps from the old bilateral,
voice-driven OTC trading model to new open, electronic trading
venues:
SEFs.
This was a mammoth undertaking. The global OTC swaps market
had a notional value of $630 trillion at the end of 2014; in
previous years the market was even bigger. Reforming swaps was
about more than just SEFs. Dodd-Frank also said swaps
transactions would need to be processed through central
clearinghouses and reported to swaps data repositories. In
effect, the statute gave birth to three new primary
institutions to manage the risk associated with swaps dealing:
SEFs, swaps clearinghouses and swaps data repositories.
In the lawmakers’ ideal, 2010-era vision, cleared swaps
(some would be allowed to remain uncleared) would eventually
migrate to an execution model that looked a lot like the equity
market. The dominant trading protocol — the mechanism to
match buyers and sellers — would resemble the real-time,
transparent order book in use throughout the world’s major
equity exchanges, with bids and offers ranked by
competitiveness and displayed anonymously to give participants
visibility into the best market around every security available
for trade. Though opacity once ruled, now all swaps
participants would see the same prices and be able to trade
with one another free of intermediation and interference. In
derivatives circles this trading nirvana soon had a name:
all-to-all.
In practice, all-to-all was always going to be a tough sell.
Both Bloomberg and Tradeweb have operated electronic platforms
for swaps trading since the mid-2000s. Until Dodd-Frank,
volumes on these platforms were flat to nonexistent. Absent a
regulatory shock, the derivatives industry had no appetite for
electronic swaps execution. Swaps traders were accustomed to a
world in which different participants patrolled circumscribed
domains of expertise and influence. The buy side contacted
dealers with order requests; dealers would figure out a market
among themselves, leaning on IDBs for assistance, before
quoting a price back. Voice was the dominant means of
communication, and personal relationships were essential to
finding the best price. Dealers liked that world because it
allowed them to feather a fee into the spread between the price
they settled among themselves and what they quoted to the buy
side. The IDBs survived on execution commissions. The big
buy-side firms could shop among dealers for the best terms,
confident that a larger trading book was a pathway to
more-exclusive dealer access and better pricing. Everyone had a
stake in the old system; forcing swaps to trade electronically
on anonymous order books would kill the edge most participants
in the market enjoyed.
From 2011, when the CFTC began the difficult task of
translating Dodd-Frank’s occasionally inscrutable precepts
into binding rules, resistance from the swaps industry was
predictably intense. At different times over the past five
years, market participants have contended that swaps reform
would inhibit financial innovation, freeze liquidity, drive
derivatives trading offshore, kill corporations’ ability
to hedge risk and destroy the swap as we know it. To date,
there has been no flood to vindicate these antediluvian
predictions of woe. Despite fierce initial resistance, most
incumbents have embraced, however reluctantly, the need for
reform. Mandatory exchange trading of swaps began in early
2014. SEF volumes are now dominated by ICAP, Tradition,
Bloomberg and Tradeweb, according to Clarus Financial
Technology. All these players entered the SEF era with existing
client bases and established strengths. Only trueEX had to
build its house from scratch.
“At the beginning we had no customers,” says
Hirani. “We had nothing. It takes money and time to
connect to SEFs. Most people wanted to wait and see how the
arms race would evolve.” Initially, dealers were reluctant
to do business with an untested execution venue because they
had no idea which of the original 24 SEFs would be most
successful in attracting liquidity. The buy side hesitated to
send business trueEX’s way because the company had no
dealers. SEFs needed to plug into clearinghouses that warehouse
the risk and hold collateral. TrueEx had many ducks to line
up.
But Hirani saw an opening. As 2013 began, an arcane debate
emerged over whether institutions with a declared intention to
operate SEFs should apply to be designated contract markets (or
DCMs, the legal term for an exchange) or wait to register as
SEFs once the CFTC finalized rules. TrueEX decided to register
as both, changing its name from trueSEF in the process. Because
the rules around DCMs were already in place, trueEX could begin
live trading and testing before SEF registration and the
official timeline for mandatory electronic execution of swaps
kicked in. Other would-be SEFs hesitated as they waited for the
rules to be finalized — and suffered as a result.