Put three men and a FIXGlobal’s Edward Mangles around a table; serve them lunch and let the tapes roll. FIXGlobal listened in on a conversation that ranged from regulators to risk and from FX to FIX.
Edward: In defense of the regulator … how should they know what’s going on when neither the sell nor buy-side seem to know?
Vincent: Recent events have shown the divide between the financial market participants and the regulator. For example, the Lehman’s mini bond issue has forced a strong dialogue between the regulator and, in particular, the broker side. But the engagement is slow.
Kent: Retail brokers tend to have a strong voice here in Hong Kong and over the years have developed a strong working relationship with the regulators. Local brokers can at times be pretty outspoken and have proven on many occasions to be an effective lobbying group. From our perspective international brokers tend to be less visible in some of these debates. We see certain common characteristics across Asia where understandably there is a good deal of focus on protecting the retail investor given the high retail investor participation in many of the stock markets in Asia including Taiwan and Korea. The challenge has certainly been in the retail space where there is an overlap of regulatory responsibility in approving and offering products.
Edward: Are we asking the impossible of the regulator to create the same rule book for retail and institutional investors?
Kent: The general principal is that retail investors are less savvy and experienced and regulations need to be explicit. There is a general assumption that as professional investors, institutions can operate with greater flexibility since they can understand the risks in a more sophisticated way. Taking account of this framework then it will not be possible to standardize for both types of investor. The risk is that setting minimum requirements to protect the retail investor may not suit the way business is transacted at an institutional level. Here we advocate consultation and support stronger trade associations.
Vincent: I don’t think you can realistically expect the same regulations for retail traders as for big institutional investors. That’s a utopia that’s never going to exist. These two groups of investors have different needs. Many regulators – in Europe for example and Luxembourg in particular with their efforts to push through the UCITS 4 protocol – understand that you need different protocols for retail investors.
Kent: But Vincent, every investor has the same goal: making money. It’s only the detailed requirements that are different.
Gerry: There’s certainly a larger burden on the big firms to uphold ethical, legal and fiduciary standards.
Kent: Yes. Retail investors don’t generally have the same constraints on their activities. Institutional investors need a more developed investment process and must ensure fair treatment across all clients regardless of size and fees. Institutional investors will undoubtedly be looking at different investor objectives – for one, they need to be able to implement their strategies in much greater volumes, and in scale, for example.
Edward: How about the role of regulators in curtailing short-selling in many markets? Knee jerk or long-term strategy?
Kent: I’d like to see the ability to short-sell fully resumed as soon as practically possible. We’re now in a situation where some markets have suspended it, and some are allowing it again. This is not ideal. I certainly see the temporary prohibition as a knee-jerk reaction and understandable given the groundswell of public opinion and corporate pressure as the financial crisis took hold – not all of this opinion was entirely rational. In fact, short-selling restrictions can reduce volumes for trading in the markets overall. For one, we have a 130-30 fund. So in this fund, if we’re limited in the number of attractive long-short pair trades we can put on then we’ll just end up trading less. So it’s business that never happens and the unknown would-be client on the other side of our trade – whether they’re institutional or retail – through the exchange, never gets to take advantage of the liquidity. What we need is a greater understanding of how shorting operates. There is a lot of misconception around this issue.
Gerry: I see the value and merit in allowing short selling in varied markets. In markets that don’t allow it, the regulators need to develop this functionality. It encourages more liquidity and volume. But I do understand that in the current environment the regulators have little choice. We won’t know the full impact until later on.
Vincent: The problem is that there’s no consistency among the regulators. Some only forbid short selling on financials. It’s a disruption to competitiveness between various sectors.
Kent: Yes. And not being able to short, will reduce derivatives trading. The fact is, a lot of the shorting that goes on isn’t just one-way, but a strategy with a ‘long’ component to it as well. And funds that relied on the little performance boost from securities lending fees have also seen their returns diminished. The equity finance desks at the brokers have seen a real drop-off in trade volumes because of this.
Vincent: Now the regulators are trying to encourage investors to buy again in a bear market – and there’s a lot of inconsistency between the messages they’re sending now and what they were telling us six months ago.
Few markets can boast the growth numbers seen in the South Africa trading community over the past five years. Technology provider, Peresys, has championed the development of electronic trading and FIX during this period. Ashley Mendelowitz, CEO of Peresys, looks at what other emerging markets can learn from the southerly nations experience.
The adoption of the FIX Protocol and concomitant growth in electronic trading in South Africa has been nothing short of prodigious. A little over five years ago the local trading environment had the characteristics of your typical turn of the century emerging market – comparatively low volumes, telephonic orders, paper based order management and error strewn post trade administration.
Half a decade later, and the picture has altered in dramatic fashion. The value of cash equities traded on the local exchange has sky-rocketed to US$34.6 billion in October 2008, from US$6.6 billion five years earlier, an impressive 424 percent increase. Offshore originated electronic trading accounts for up to 25 percent by value traded, while upward of 90 percent of local institutional orders are now routed electronically. Capping the meteoric growth, South Africa now has the largest single stock futures market in the world, by number of contracts.
None of this would have happened without the FIX Protocol.
The seeds were sown as far back as 1997 when the top two or three buy-side firms began to explore options in terms of taking their equity desks electronic. It quickly became clear that the barriers to automation were high and wide. These included:
Non-existent order management systems on the buy-side and sell-side
Telecommunications monopoly and exorbitant bandwidth costs
Reluctance of traders on either side to change their work flow
Lack of open application programming interface (API) to the exchange matching engine or broker trading systems
Virgin territory insofar as a globally accepted messaging and session management protocol for pre-trade and trade messaging
Lack of local or international vendor appetite to invest in building a workable solution that addressed all of the above barriers.
Breaking Down Barriers It took some five years to gradually knock down or climb over the barriers above, through cash and resource investment, constant evangelising the benefits of electronic order routing by the converted (including our firm) and, critically, the buy-in and backing of a buy-side champion. The first buy side champion in South Africa not only committed its firm to the concept, but also made it clear to its sell-side counterparties that the telephone would be phased out within twelve months.
In 2003, the implementation of a first buy-side to ten brokers began, as well as the selection of a FIX engine provider flexible enough to price their product at ‘emerging market’ levels. Within three years, the first FIX hub had established a South African footprint spanning eight of the top ten buyside firms, the top thirty five broker members of the local exchange and a large chunk of local and international hedge funds trading SA equities.
Once Direct Market Access (DMA) was allowed on the SA equities exchange, the ability for brokers to receive orders via FIX played a key part in the exponential growth in DMA trading volumes originating from outside the country. Multinational investment banks and hedge funds could leverage their existing FIX infrastructure to trade into SA in a cost effective, reliable and high speed manner.
Today all the barriers to electronic trading have been removed:
Local and offshore vendors have successfully rolled out FIX compliant OMS products
Local telecom competition and the decision to connect the local Hub to any global FIX network based on demand has translated into cheap connectivity
Traders have seen the financial benefit of increased order flow through electronic messaging
The exchange implemented a comprehensive and well documented API
FIX has addressed all user concerns about a global standard for messaging formats, workflow and session management
Electronic trading pioneers paved the way for other buy-side/brokers/vendors to follow in offering products that exploit FIX, including hubs, order management systems, algorithmic trading and IOIs
The Oxford English Dictionary defines 'challenge' as the “move from one system or situation to another”. It is a word Toby Corballis, CEO of Rapid Addition, believes, all too easily describes the financial turmoil of the past six months. With a particular focus on EMEA, Corballis examines these challenges and the associate risks facing firms and software vendors across the financial marketplace over the coming 12 months.
Given the continuing volatility of global markets, large-scale movement of people, data and systems, challenge looks set to be the order of the day. Or, in the words of Robert Zimmerman, 'The Times They Are A-Changing', in the world of electronic trading, like many others, 'movement begets change and change begets risks'. Over the following year, the industry looks set to face a series of challenges, change and risk.
Change #1: Consolidation of software
With apologies to any egg-sucking grannies, once upon a time, to attract order flow, the sell-side gave away various software packages to the buy-side. It was the same kind of logic applied by proponents of the ubiquitous loyalty card, and buy-side firms saved money, as they didn't have to pay for their software upfront. Actually, costs were partially hidden in sellside fees and partially realised through the inconvenience of having to use a multitude of different solutions that did more-or-less the same thing but connected to different counterparties.
This may seem trivial, but it represents a seismic shift in the way systems make it to market. Money for these systems will no-longer flow from the sell-side to the software vendors. The relationship is now owned by the buy-side. No one wants to pay for something that used to be free, so it's unsurprising that there are mutterings in the corridors. Expect this crescendo to peak as many existing 'free' contracts expire, creating a drive to consolidate on as few solutions as possible. This consolidation carries a number of risks to all sides of the financial Rubik cube.
Buying software requires an understanding of the software procurement process, a process that is itself currently the subject of change. Questions like, “how long has the vendor been trading?” are likely to matter less than “who is the ultimate parent?” and “how solvent are they?”. Ownership is likely to say much about the chances of software being able to support your requirements later on. Where safety in numbers was once seen as good (vendors had more clients so less chance of going under), it doesn’t work so well if you’re in a long queue of creditors to a failed business.
Knowing who the ultimate parent of a company is gives other insights. Do the company's principals really understand my industry (they need to if you want some assurance that your system will change to keep up with the times)? Do they have a reputation for innovation? What is their commitment to Research & Development?
Change #2: Increased regulation as a by-product of political oratory
Politicians love to claim credit, deflect blame, and be perceived as tough guys. A quick scan of the local media is enough to see that the current political culture is very much one of blame. Fallout from political rhetoric tends to materialise in legislation which almost always beats the drum for “greater transparency and accountability”. What is actually meant, of course, is greater auditability, or the ability to recreate a moment in time so as to prove that the course of action taken was fair and in the best interest of the client. This is all good and there are many ways to achieve it, however it would be hard to argue that computer records were anything other than the most accessible of these.
Imagine trying to model all of the Credit Default Swaps (CDS) contracts into which Lehman’s entered. One problem is that a CDS could be created in so many ways: phone, instant messenger, and so on. Finding and recreating all of these would be a nightmare. That there is an appetite by the regulators for things to be more auditable is evident in recent speeches by Charlie McCreevy, the European Commissioner, who has been looking to introduce legislation to create more on-exchange trading of CDS trades.
If more assets are traded on-exchange that implies that more software connections are required to connect venues with participants. That, in turn, implies more trading platforms and more capacity to handle increased transactional volumes by the participants.
While MiFID has now been in force for almost a year and a half, the recent market turmoil has given market transparency, best execution – and a whole host of other issues – a new urgency. FPL brought together a roomful of experts from the Exchanges/ECNs, buy and sell-side to discuss the impact to date, of MiFID, and its strengths and limitations addressing the new financial world order. Extracts of the session follow.
Daemon: Let’s dive straight in. How successful has MiFID been in creating an open infrastructure in Europe?
Charlotte: MiFID has had a large impact and has certainly opened up the market. The main challenge is that there’s a fair amount of work to catch up on. We have new MTFs (Multi-lateral Trading Facilities) and more coming through. This brings new competition and means that the market needs to catch up on these developments. We still have a choice of Central Counterparties and we need consolidated data to have an EBBO (European wide Best Bid and Offer). These are the high level issues that are still out there.
Joseph: I agree. We still have a long way to go. The key challenges are the need for smart-order routing, to give us best execution, and bringing more transparency into the market through better consolidation of data.
Daemon: Do you feel we’re going to see a major shift towards the consolidation of data in the short to mid-term?
Charlotte: We haven’t seen it yet, but we are seeing expanding message traffic coming from all firms. A pipeline of six to ten MTFs will be in place by the end of this year, and this increase in traffic will mean that smart-order routers are going to say at some point, ‘enough is enough’. Then we’ll see some consolidation.
Duncan: When you’re talking about openness and Europe, you have to look at the level of openness across all the countries. So until this October, for example, Italy was not open for competition, but now with the Boursa Italia system upgrade, the system now allows for competitive trading.
The other issue is Spain, which definitely does not have an open infrastructure. There needs to be quite a bit of change within the settlement process in Spain so you can have trading on more than one platform, and so people can gain the same efficiencies in Spain as they do for other markets.
From a technical perspective – a lot of the new MTFs have adopted FIX in a big way. What we need is for the other venues to adopt FIX to standardise the way we connect to all the different venues.
Daemon: How about Smart Order Routing (SOR)? What is your assessment on its importance in the current environment?
Duncan: In Europe, if you’re a broker or investment firm, you’ll already have a lot of different places to get order routing capability connecting into exchanges and MTFs. You can use SOR vendors or your own technology. But because brokers have the capability at the level above the exchanges it’s not clear there is a demand from that community for routing between the platforms. If order routing becomes a market place norm and people want or expect it, then we’ll deploy it. But we’ve not yet seen a clear demand.
Kristian: It’s important to remember that it’s not just brokers that are tasked with demonstrating best execution – we have to demonstrate best execution to our clients everyday. To do that, SOR is paramount. When we pick up the phone to deal with a broker, we expect them to have the same capability. The issue we see is the capability of foreign routers. How sophisticated are they? It’s all very well to say trade Royal Dutch on two different exchanges, but have we reached the point where we can trade multi-listings with the same security? There still isn’t that kind of clarity of transparency as to how this will work.
Joseph: SOR is key in Europe. It’s not only a question of getting access to all the venues. It is the ultimate way to make sure you have best execution under MiFID. But a lot of things need to be incorporated. It’s about pricing across multiple venues, its about volume at a specific time, the probability of getting filled at a specific time and looking for hidden liquidity that may be generated on these exchanges.
It’s not enough to be able to trade, for example, 5,000 shares over five different venues. You need to be able to dynamically direct your orders to venues where there is liquidity at this point in time.
In January 2010, the Tokyo Stock Exchange (TSE) launches its new, high-profile, Arrowhead exchange trading system for cash equities. TSE defines Arrowhead as its next generation trading system combining low latency with high reliability and scalability. However, to the surprise of many in the global trading community, Arrowhead will not include a FIX gateway. MetaBit Systems’ David Chapel examines the decision and argues that the Japanese exchange should reconsider the decision.
In September 2008, the Tokyo Stock Exchange (TSE) announced its plans for ‘Remote Trading Participant Services’ that would allow offshore firms, with no branch in Japan, direct market participation – a novel proposition in Japan. Initially, during the tender phase, TSE considered offering a FIX Gateway to the new Arrowhead system, however, a survey of exchange participants indicated that broker members had minimal interest in the global communication protocol.
The survey results came as a surprise to many, but a closer look at the TSE broker members shows it leans heavily towards smaller domestic players. Currently, TSE has 106 broker members, including foreign securities firms that have registered their local entities as a ‘General Domestic Trading Participant’, and 11 foreign members. Of these only around 40 members (split almost evenly between foreign securities firms, including those registered via their Japanese legal entity and domestic securities firms offering international trades) would possibly see the need for a FIX gateway.
Given the advantages that a FIX gateway would have offered to Arrowhead’s future Remote Trading Participants interested in the protocols ability to interact with a local exchange through a standardized API, we would urge the TSE to reconsider its decision, despite the current low demand among its domestic members.
Why not FIX it? FIX is not a new concept in Japan. At MetaBit, we have offered a FIX-to-native exchange gateway to all major securities exchanges in Japan since 2004. The development of Arrowhead provided our company with the catalyst to re-architecture the existing FIX gateway with a focus on low latency and scalability. This need for speed was particularly important given the belief among exchanges that FIX is slow. Our aim was to bring FIX-to-native exchange connectivity below 500 microseconds of additional latency under sustained load, a goal which we have more than achieved. In addition, we have made extensive use of the Orc CameronFIX Universal Server to provide the core FIX connectivity.
Technical challenges and solutions for FIX During the development of our upgraded FIX gateway, we had to consider the following technical challenges of providing a FIX implementation for direct exchange connectivity:
Performance is paramount; request latency (time to exchange) and request throughput (requests per second) represent the key metrics. Larger global members require sub-millisecond latency with throughput exceeding 1000 orders/second.
For scalability, most Japanese exchange architectures require multiple physical connections (so called Virtual Server or VS’s). Each VS is limited to a certain throughput by the exchange; higher throughputs can only be achieved by a broker member subscribing more VS’s. Due to cost, smaller and mid-tier brokers typically subscribe to 20 to 40 VS whilst it is common for large members to run above 100 VS’s per exchange. Efficiently managing and load balancing across such a large number of connections leads to a significant increase in complexity.
Each exchange API has a unique message protocol and message structure. Creating a standardized multi-exchange product requires custom FIX mapping for each implementation. It is the aim to keep custom FIX tags to a minimum possible whilst adhering to the global FIX Protocol.
The FIX API is a simple asynchronous model, well suited to high throughput bidirectional messaging. However, Japan’s older exchange APIs use a synchronous delivery model, providing batched order requests (20 orders per batch) to increase throughput. This complicates mapping between the FIX- and the native exchange API and increases implementation complexity.
Members can run many different types of hardware and operating systems; hence a vendor needs to support as many systems as possible.
Q: Where does an 800-pound gorilla sit? A: Anywhere it wants.
I landed my first job in the financial industry back in the Halcyon days of the mid-1990s. From my naïve perspective, everything was wonderful. Stocks only went up. Nobody worried about a company’s P/E ratio, or if it were capable of turning a profit. If it had a “.com” in its name, it was a guaranteed winner. A website that resold airline tickets had a higher market capitalization than the airlines. Within the financial industry, technology was King, and with money growing on trees, it seemed firms had unlimited IT budgets and armies of software developers.
Exchanges, in the mid-90s, were the 800-pound gorillas of the day. They could implement proprietary standards, and firms had no choice but to adopt them. With liquidity centralized on the exchanges, there was no real competition, so everyone in the industry let the gorillas sit wherever they wanted. And with unlimited IT budgets and armies of software developers, accommodating the seating needs of several gorillas wasn’t all that painful.
What a difference a decade makes … Times have changed. With the global economic crisis, IT budgets and headcounts are shrinking across the industry, and costs must be justified. Liquidity in many regions has become decentralized, with new generations of ECNs and ATS’ taking market share from central exchanges. Interexchange linkages mean that firms don’t have to connect to everyone to achieve price protection and best execution although, obviously, exchanges would prefer firms access them directly and not through their competitors. Firms are discovering they now have far more choices in finding liquidity, and they have less reason to tolerate expensive proprietary or non-standard interfaces.
Is FIX the solution? FIX provides benefit to the financial industry in the form of a “network effect.” In theory, work done to support FIX for one market can be reused with other markets, effectively sharing the development cost. Proprietary protocols lack the ability to generate network effects and increase costs for the industry. A market that only supports a proprietary protocol is like an 800-pound gorilla that wants to sit on my laptop. The resulting situation is clearly amenable to the gorilla, but to me it’s expensive and inconvenient.
Proprietary protocols are not the only method of escalating market participants’ costs. While many markets claim to implement FIX, some deviate from the standard protocol to varying degrees, which drives up costs. Deviations usually fall into three categories: session, syntax and semantics.
Session costs With a wide variety of established commercial and open-source FIX engines, session level deviations are few, but notable examples do exist. In these cases, the cost to a market’s participants can be severe. Firms using commercial FIX engines usually do not have the ability to modify an engine to support non-standard session behavior, so firms find themselves at the mercy of their engine vendors. They, in turn, are left scratching their heads wondering why the particular exchange deviated from the session standard and how they can recoup their costs to work around the exchange’s issues.
Syntax costs Deviations in syntax are more common. These may include failing to send required fields, or forcing participants to send custom, user-defined fields that are not required by the FIX specification. While these do carry some expense and inconvenience, they are not usually catastrophic.
And semantics Semantic deviations, however, are a market participant’s worst nightmare. The FIX Protocol defines precise semantic usage. Business processes are represented by standard transactional flows of messages, which themselves carry defined identifiers, states and key fields. Market participants’ systems are built assuming certain fundamental semantic behavior. Any nonstandard semantics will often require costly changes and could impose considerable additional latency in the participant’s system.
The costs to the industry of nonstandard behavior include analysis, development, QA, deployment, and integration testing. Firms who use vendor products must convince their vendor to support the non-standard behavior and must wait until the vendor can find the time to create, test and release the change. Just as the “network effect” can reduce costs for standards compliant implementations, nonstandard behaviors multiply these costs. Every $10,000 change to support nonstandard behavior made by 1,000 market participants costs the industry $10 million.
What makes them tick? Understanding the gorilla’s psychology may be useful in correcting its behavior.Gorillas usually choose to deviate from the protocol and sit on inappropriate objects for one of three reasons: they don’t know any better; it allows for easier interfacing with their internal systems; or they believe they are implementing new business functionality not supported by FIX.
MiFID has undoubtedly made its impact on the industry. FIXGlobal collates opinion from Nomura’s Andrew Bowley and BT Global Service’s Chris Pickles on the success of MiFID and its next manifestation.
Having digested the massive changes MIFID brought to the EU two years ago, what has the financial community learnt from the content of MIFID 1 and the process whereby it was developed and implemented?
Andrew Bowley (Nomura): First and foremost we must conclude that MiFID has worked. We now have genuine competition and higher transparency across Europe.
Costs are down. MTFs (Multilateral Trading Facilities) have brought in cheaper trading rates and simpler cost structures, and most exchanges have followed with substantial fee cuts of their own. Indeed this pattern is also clearly demonstrated by exception. The one country where MiFID has not been properly introduced is Spain and this is one country where fees have effectively been increased. This teaches us that complete implementation is the key and the European Commission needs to look hard at such exceptions.
We have also seen clearing rates reduced, though the fragmentation itself has caused clearing charges to increase as a proportion of trading fees as typically the clearers charge per execution. Interoperability should help address that, assuming a positive outcome of the current regulatory review.
In terms of lessons learnt from the process we must consider that we have experienced a dramatic change in a short period of time, and should allow more time for the market to adjust before fully concluding or looking to further wholesale change. We are certainly still in a period of transition - new MTFs are still launching; and the commercial models of all of these, mean that we are far from the final equilibrium. To have so many loss-making MTFs means that we cannot be considered to be operating in a stable sustainable environment.
Chris Pickles (BT Global Services): MiFID is a principles-based directive: it doesn’t aim to give detail, but to establish the principles that should be incorporated in national legislation and that should be followed by investment firms (both buy-side and sell-side). Some market participants may have felt that this approach allowed more flexibility, while others wanted to see specific rules for every possible occasion. The European Commission has perhaps taken the best approach by allowing investment firms and regulators to establish themselves what are the best ways of complying with the MiFID principles, and has perhaps “turned the tables” on the professionals. If the European Commission had tried to tell the professionals how to do their job, the industry would have been up in arms. Instead, MiFID says what has to be achieved – best execution. Leaving the details of how to achieve this to the industry means that the industry has to work out how to achieve that result. This takes time, effort and discussion. FIX Protocol Ltd. helped to drive that discussion by jointly creating the “MiFID Joint Working Group” in 2004. And the discussion is still continuing. A key thing that the industry has learned – and continues to learn – is to ask “why”. Huge assumptions existed before MiFID that are now being questioned or proven to be wrong. On-exchange trading doesn’t always produce the best price. Liquidity does not necessarily stick to existing 100% execution venues. Transparency is not sufficient by just looking at on-exchange prices. And the customer is not necessarily receiving “best execution” from today’s execution policy.