Sassan Danesh, FPL Co-Chair, Global Fixed Income Committee, and Managing Partner, Etrading Software explains how and why the adoption of the FIX connectivity protocol in fixed income trading came about.
Historically, a large percentage of fixed income trades have been bilateral OTC deals arranged via a sell-side broker. Executing these deals required the broker to field a large sales force to handle calls from the buy-side and facilitate the transaction with the broker’s market-makers. Needless to say, this model involved extensive costs, which led to the emergence of early fixed income electronic trading platforms at the turn of the millennium, seeking to provide a low-touch and streamlined execution service for bond trading.
However, the market share of these venues was small due to a number of challenges. One of the hurdles faced by market participants attempting to use these platforms was that connectivity to them was difficult and often rather expensive. This was because the fixed income trading workflows were much more complex than for equities. This meant that using a standard such as FIX presented many challenges, as sometimes the messaging language did not offer the functionality needed to manage these workflows and as a consequence the early platforms each developed their own individual proprietary protocols. The financial implications of this were huge, with some firms estimating it was costing multiple times more to connect to fixed income venues via a proprietary protocol, versus equity trading platforms offering standardised FIX connectivity.
For a while, the financial benefits of moving to electronic trading allowed firms to absorb these large connectivity costs. However, the impact of the financial crisis and the resulting wave of new regulation led to reduced profitability, increased obligations on the industry to enhance transparency and a more fragmented marketplace emerged. This accelerated the need for a more efficient electronic trading environment.
The role of FIX
In mid-2011, representatives from the broker-dealer community, approached the non-profit FPL (FIX Protocol Ltd.) organisation in order to work towards establishing FIX as the open standard for connectivity to both existing and new venues, so that the industry could benefit from the greater transaction efficiencies and the lower cost connectivity enjoyed by equities, and also increasingly by the FX and derivative markets.
In response to this request, FPL formed a group to address the challenges emerging in this environment. Through the work of this group, in 2012 FPL produced recommended guidelines for how FIX could be used by emerging Swap Execution Facilities (SEFs) to trade interest rate swaps (IRS) and credit default swaps (CDS). These guidelines are now being used to support FIX implementations by a number of SEFs. The urgency to prioritise these products was dictated by the imminent regulatory need for SEFs to be operational.
Once the swaps guidelines were complete, the group then turned its attention to the use of FIX in the cash bond markets and resulting FIX guidelines were released in February of this year.
The process of creating the recommended FIX guidelines involved successfully overcoming a series of issues:
Collaboration – Given the prevalence of proprietary connectivity protocols in fixed income, many trading venues were not used to the idea of collaborating with their competitors to establish a global standard for the benefit of the community. FPL is structured as an independent and neutral industry-driven organisation, bringing together market participants to address the business challenges impacting the trading community through the use of standards. These factors were critical in reassuring stakeholders that a suitable forum existed for discussing the technical challenges and arriving at a set of guidelines that would deliver industry-wide benefit, independent of any given venue or broker.
Scope – The fixed income markets comprise a multitude of individual product types, from government bonds to high yield instruments and also include derivatives such as IRS and CDS. Trading is global in nature, with regional differences. The FIX guidelines were able to address this large scope due to FPL’s global presence and diverse membership, which includes buy and sell-side firms, trading venues, vendors, regulators and industry associations. This broad membership base of firms from across the world enabled the guidelines to benefit from the participation of experts with a strong knowledge of each of these markets.
Relevance – Given that trading venues already had existing proprietary connectivity implementations, a key objective of the initiative was to ensure that the FIX guidelines would capture the existing established market practices. To achieve this goal, FPL listed over 80 different business workflows currently used in the industry and provided recommendations for each workflow individually, showing how FIX could support that specific practice (where necessary this also led to the development of additional FIX functionality). Taking this approach ensured that all dominant market models were accommodated in the FIX guidelines.
Adoption – One of the success factors for the initiative was ensuring that the FIX guidelines could be adopted easily and to minimise the cost implications of transitioning to FIX. Many of the bond electronic market places also offered derivatives trading. Therefore, FPL ensured that wherever possible the bond guidelines were consistent with those published the previous year for swaps, so the venues could benefit from the resulting cross-asset synergies. The guidelines also benefited from the use of FIX in the listed derivatives space, which allowed market participants to leverage their existing investments in FIX infrastructure from these other asset classes. As a result, many venues have started to adopt these guidelines and more are expected to announce their support in coming months.
This work is now yielding large benefits to the industry, by helping to meet the implementation challenges of new regulations. To name a few:
– The Dodd-Frank Act in the USA will result in the establishment of new swaps trading venues called Swap Execution Facilities (SEFs); this is likely to generate a high demand for new fixed income connectivity. Already, many brokers and multiple SEFs have announced that they will be adopting the new FIX guidelines, successfully overcoming the original implementation and connectively challenges feared.
– Basel III is resulting in brokers holding less bond inventories, which in turn is causing increased fragmentation in the industry. The result is a proliferation of new electronic bond markets attempting to usurp the traditional role of the broker. These new venues require new connectivity from industry participants to ensure efficient price discovery and sourcing of liquidity across the market – a requirement that is best met through electronic trading practices supported by standards such as FIX.
– MiFID II in Europe is looking to achieve additional pre-trade transparency in the fixed income markets (both bonds and swaps), with results that are expected to be similar to the Dodd-Frank Act in the USA.
The work of FPL won’t stop here. FPL is continuing to update the FIX guidelines in-line with the evolving regulatory environment, ensuring that market participants can use FIX to meet their business needs. Additionally, the guidelines themselves are being extended to cover some of the less common workflows such as different permutations of cross-asset trades within fixed income. For example, common strategies such as basis trades and butterflies are now being incorporated into the guidelines.
Finally, FPL has just launched a new initiative which has come about due to the trading element of fixed income becoming more electronic and market participants expressing a desire to automate additional elements of the trading process. A prime example of this is the administration that currently takes place to grant permission for a trading relationship to occur on an electronic trading venue. As each trading relationship will need to be validated on ‘day one’ of the new SEFs going live, this is an initiative that could present significant efficiency savings for these markets.
©BestExecution | 2013