Andres Araya Falcone of the Santiago Stock Exchange explains how FIX is increasing the range of services available to traders in Chile and throughout Latin America.
How is FIX facilitating DMA into the Santiago Stock Exchange?
The first concept of DMA in Chile began with what we call “direct traders” (buy-side traders) facilitating these specially authorized institutional clients, to send direct orders to the market via a “broker sponsor”. Thus, pension and mutual funds, insurance companies and other institutions, using trading terminals provided by the Stock Exchange, can trade directly in our market. The next natural step was the incorporation of electronic networks to attract order flow from the U.S., Europe and neighboring countries in Latin America, especially Brazil.
In 2006, we built the first FIX interface using version 4.0 to connect to the Marcopolo Network, to attract the order flow of our local equities market. After that, the Santiago Stock Exchange launched its initiative to modernize the equities electronic trading system and developed Telepregón HT, jointly with IBM, which went live in June 2010. This system is ready for algorithmic trading flow since it supports a throughput of over 3,000+ orders per second with sub-millisecond latency. In designing the system, we decided to use FIX 4.4 to enable easier connection via DMA with other exchanges, sell- and buy-side firms and market information vendors. This has greatly facilitated the connection to different networks, such as Bloomberg, Fidessa and SunGard, among others. For all these initiatives, FIX has been crucial in facilitating the integration with these listed networks. During 2011 we will announce new network agreements.
Currently, referring to the equity market, 11% of order flow comes from DMA which represents an average of a 27% increase over the last 6 months, today 19% on average comes from Internet retail order flow, and the rest comes from traditional OMS and Trade Work Stations.
As foreign investment into Chile and the Chilean market continues, how will the Santiago Stock Exchange upgrade its platforms to meet increased investor and trader demands?
In 2010, the Selective Share Price Index (IPSA), the country’s main stock market indicator, gained 37.6% in Chilean pesos (equivalent to some 46% in dollars). Share trading on the Santiago Stock Exchange rose to US$60 billion in 2010, up 30.5% from 2009, setting a new annual record. Trading was particularly strong in the second half of the year, which accounted for almost 60% of the annual total, reflecting strong demand from both local and international investors.
At the same time, by the end of 2010, the Santiago Stock Exchange had signed a linkage agreement with Brazil’s stock exchange, BM&FBOVESPA, heralding the latest in a series of cooperativeprojects being run between Latin American bourses. The agreement, signed on December 13th, will enable connectivity between both exchanges for order routing and market data dissemination. It also includes separate initiatives for further development of the Santiago Stock Exchange’s derivatives market, the establishment of joint initiatives related to settlement, clearing and central counterparty services, as well as access to the BM&FBOVESPA /CME trading platform from Chile.
Market participants in both countries will be able to route orders for stocks, stock options and related derivatives listed on the other’s exchange. Both exchanges will also be able to receive and distribute each other’s market data. Clearing and settlement of orders will be done according to local market rules of listed instruments. These kinds of initiatives imply that the Santiago Stock Exchange’s IT platform has to be prepared to manage more than 6 million orders per day.
What plans does the Santiago Stock Exchange have to accommodate High Frequency Trading and algorithmic order flow?
We are working as an integrator of a state of the art product for algorithmic trading. In conjunction with Streambase, FIXFlyer and IBM WFO, we are creating a product we will call “Broker in a Box”. The idea is to provide a framework for capital markets, including a set of algorithmic order execution strategies designed to achieve best execution, access liquidity, minimize slippage and maximize profits for trading operations. These algorithmic trading strategies (like VWAP, TWAP, Arrival Price / Implementation Shortfall, etc.), are provided as fully customizable EventFlow modules which can be used in conjunction with the frameworks. Trading firms will be able to modify each algorithm to reflect their own “secret sauce” and to differentiate their trading strategies in the market. The Santiago Stock Exchange will provide an “all in one” solution: integrated markets, market data (from Integrated Latin America Market (MILA), NYSE and NASDAQ), co-location, monitoring, local support, etc.
Timothy Furey, Goldman Sachs, Neal Goldstein, Nomura and John Goeller, Bank of America Merrill Lynch, shed light on the process of managing risk in electronic trading.
At the start of this year, FPL announced the completion of an initial set of guidelines, which recommends risk management best practices in electronic trading for institutional market participants. In the third quarter of 2010, FPL launched a group to raise awareness regarding the implications of electronic trading on risk management and to develop standardized best practices for industry consideration. Over the last few months, the group, which consists of a number of senior leaders in electronic trading from the major sell-side firms, has been working on developing this set of guidelines to encourage broker-dealers to incorporate a baseline set of standardized risk controls.
The objective of the guidelines is to provide information around risk management and encourage firms to incorporate best practices in support of their electronic trading platforms. In today’s volatile marketplace, the automation of complex electronic trading strategies increasingly demands a rational set of pre-trade, intra-day and pattern risk controls to protect the interests of the buy-side client, the sell-side broker and the integrity of the market. The objective of applying electronic order risk controls is to prevent situations where a client, the broker and/or the market can be adversely impacted by flawed electronic orders.
The scope of the particular set of risk controls included in the guidelines is for electronic orders delivered directly to an algorithmic trading product or to a Direct Market Access (DMA) trading destination. The recommended risk controls included provide the financial services community with a set of suggested guidelines that will systemically minimize the inherent risk of executing electronic algorithmic and DMA orders.
In what area are sell-side and buy-side firms’ risk controls most in need of improvement?
Timothy Furey, Managing Director, Goldman Sachs and FPL Risk Management Committee Co-Chair: One of the observations coming from the FPL risk sessions was that the buy-side and sell-side had really given considerable thought to their own individual firm’s risk controls. That said, both the sell-side and the buy-side should continue to focus on pulling together a standard, consistent base set of controls that their respective firms can reasonably implement. Therefore, it is more a question of standardization than a need for specific improvement.
John Goeller, FPL Americas Regional Committee Co-Chair and Managing Director, Global Execution Services, Bank of America Merrill Lynch: This effort was not necessarily to address an apparent deficiency in how the buy-side or the sell-side handles risk management, but to codify a set of best practices for all firms to use. It was generally accepted when we started this process that all firms implement some level of risk controls around their business. Our goal was to identify the most common ones and ensure that we have a base set of controls that all firms can implement.
Neal Goldstein, Managing Director, Nomura Securities International and FPL Risk Management Committee Co-Chair: It is important for the buy-side community to recognize that their efforts to implement risk management controls for electronic trading will be more effective when a collaborative effort is made with their sell-side executing brokers. For algorithmic and conventional (low frequency) DMA orders, the first line of defense should be the risk controls incorporated within the buy-side OMS/EMS. The most effective risk control is to prevent a questionable order from leaving the buy-side OMS/EMS. A specific factor that the buy-side should be looking at more closely is the impact a given order has on available liquidity. While the order validation employed by many buy-side clients accounts for notional value and order quantity, another factor that needs more consideration is the Average Daily Volume (ADV) during the trading interval. Creating an order to trade, where the volume participation rate may exceed ADV for a given interval, can have significant adverse impact on execution price and algorithmic performance, particularly for illiquid names.
What role, if any, should the exchanges play in implementing risk controls?
John Goeller: Most exchanges have technology solutions (in certain situations it is mandatory) around risk management. In some cases, these tools are optional and only work when accessing a particular exchange. Regardless, if a firm is utilizing exchange provided tools, home-grown, or vendor-supplied, they can still leverage our efforts to understand whether their tools are implementing industry best practices.
Paul Squires, Head of Trading, AXA Investment Managers opens up about the relationship between the buy-side and exchanges, and the perceived effects of recent consolidation among exchanges.
From Trading Desk to Trading Floor
We trade on an exchange in the name of a broker, which means there is a buffer between the exchange and the buy-side. The interaction we have with the exchanges and MTF’s works much better now. The MTF’s have done a good job engaging with the buy-side over the past few years, which makes a lot of sense when you think of the evolving landscape of market structure. Historically, buy-side firms and exchanges were never quite sure if they needed to pay much attention to each other; however, there is a much more collaborative dialogue now. Most buy-side desks have mixed feelings about some of the bigger exchanges, in much the same way that some of the brokers have mixed feelings about the positioning of exchanges. On the up-side, there is a sort of national, utility element to the exchanges. For things like index funds, primary exchanges own the end of day official pricing.
Before MiFID, the primary exchanges were responsible for more of the trade and transaction reporting and it was easier to interpret that data compared with the fragmentation of trade reporting following the first MiFID installment. On the buy-side, we have this simplistic view that it is positive for reporting to be centralised through the primary exchanges because having liquidity in a single venue is something we see as beneficial. Also, the level of monitoring around the primary exchanges is higher than around the MTF’s, and therefore, things like governance and robustness tend to be greater. Generally speaking, we see the primary exchange as a kind of trustworthy elder statesmen in the world of market structure. Where I think the challenges around the exchanges lie are that innovation can be bogged down by their hierarchy and organizational structure, and therefore, cannot compete quite as dynamically as some of the MTF’s, which clearly have much lighter infrastructure considerations. It is no surprise that some of the primary exchanges have lost market share to the MTF’s, who have been nimble, technology focused and reactive in the face of a changing environment.
We find it quite fascinating to see what will happen. Given the rate of market expansion, globalization and regulatory changes - all of which lends itself to consolidation - it was an inevitability. Exchanges have to be forward thinking about what their long term roles will be and although there are different aspects to this, what we tend to focus on is cash equities only. When people think of the Toronto or London exchanges merging, they think it is kind of interesting. Deutsche Boerse and NYSE Euronext, on the other hand, is fairly mind-blowing. In a wider context, the really interesting developments for us, the market participants, are for exchanges to look into other asset classes and areas of activity to secure a revenue stream for the future. The real impetus is not from cash equities; it is very much about clearing, OTC, potentially, fixed income markets and looking at what they can do in more commercial areas.
Net Gain/Loss from Exchange Mergers
We would hope to see technical enhancements at the exchanges. By applying a rule of best practices, the things that work well for the Toronto Stock Exchange or the London Stock Exchange could be transported to the other exchange, as with Deutsche Boerse and NYSE Euronext. The technical platforms and order book layout are quite relevant, so we would hope to see some enhancement in that area. Nonetheless, I would not necessarily promote a uniform market layout or order book structure, as I do not think we need that in every single exchange we trade on. To some extent, the more that order books’ structures align, the more it helps traders who are trading multiple markets. We can pre-constrain a lot of unique exchange rules in our systems, but there are segments where human intelligence and manual control of the various elements are vital. In this respect, we would see any alignment of market practices as a fairly positive development.
The obvious potential negative outcome of the mergers is in returning to situations where the exchanges have too much of a monopolistic position and can potentially raise costs without the market having any ability to challenge it. If the MTF’s or exchanges raise their costs, we do not necessarily see that on the buy-side because of the buffer that the broker provides. There is a fairly high margin in the commission rates we pay our brokers and they cover their costs of trading our orders on the venues, and those venue transaction prices would have to increase exponentially for it to become a direct factor for us. Of course, it does eat away at margins for the brokers, and it may come to a point where they need to pass those costs on. The buy-side is somewhat safeguarded from rising venue costs, but not completely.
Infosys Consulting’s Mahendra Hingmire and Parthiv Mehta explain how FIX 5.0 can improve automation, reduce costs and increase revenue through greater efficiency.
Early FIX solutions
The FIX Protocol has evolved from supporting equities to supporting messaging requirements of multiple asset classes, including derivatives,fixed income and foreign exchange.
The explosive growth of use of FIX, facilitated by the flexibility it presents, the parallel growth and use of proprietary application programming interfaces (APIs) by the exchanges, met the industry’s immediate needs for business growth. At the same time, the earlier versions necessitated certain costs on maintenance, interconnectivity and language translators.
The flexibility to create custom tags, met the needs of individual firms, however, this practice can also lead to the generation of non-standard versions of the protocol and its widespread use can result in higher costs of implementation and a longer time for deployment for the industry. Also, the tight coupling of the application layer and the business layer in FIX4.X versions limited the ability to adapt to newer functionalities offered by later FIX versions.
Demand of the Industry and FIX 5.0
The industry as a whole needed to address the limitations of the existing protocol as well as find a protocol flexible enough to support their future requirements. FPL came together to address the dual needs of its members and the outcome was FIX 5.0 and FIXT.1.1, the FIX Session Protocol, as an answer to its members’ requirements.
Transport independence disconnected business messages from their carrier thereby allowing different versions of FIX Protocols to be run on the same session via any appropriate technology, in addition to the FIX Session Protocol. This feature helped reduce technological constraints and made it possible for firms to communicate with each other regardless of their FIX version. This is possible because FIX 5.0 runs on top of the FIX Session Protocol. Transport independence serves the industry’s need to use the existing FIX versions and also help firms reduce the future cost of implementing new FIX versions.
Yoichi Ishikawa of kabu.com Securities navigates the developments of PTSs in Japan and their effects on markets, traders and regulators.
(1) Could you tell us about the history of PTS in Japan and its growth over the past 3 years?
The history of Proprietary Trading Systems (PTS) in Japan began with the launch of PTS trading in September 2000 as the country’s first alternative stock trading platform. Initially, two brokerages developed and launched PTS operations geared primarily toward after-hours trading for retail investors, using the closing price at exchanges and VWAP for certain institutional investors. As a result, until April 2007, PTS trading never accounted for more than 0.2% of overall market volume (monthly basis). PTS trading volume, however, gradually began to expand starting in the second half of 2007 owing to the added liquidity provided by new link-ups between PTS operators and brokerage houses. In 2008, PTS midday trading was launched, offering smaller minimum price movements than the exchanges. PTS operators expanded to six firms, and a small number of international brokers began smart-order routing (SOR) operations.
2009 brought even smaller minimum price movements - less than 1 yen - and the launch of PTS stock price streaming through major information vendors such as Thomson Reuters, Bloomberg and QUICK. As a result of these advances, PTS trading exceeded 1% of overall market volume (monthly basis) for the first time in October 2009. Although the launch of the Tokyo Stock Exchange’s (TSE) advanced trading platform, Arrowhead, at the start of 2010 resulted in reduced latency and reduction of tick size, overall market trading value, including the Tokyo bourse, has not witnessed a significant increase. While PTS trading value, too, has not seen much in the way of growth, PTS trading is now primarily used by brokerage houses for algorithmic and electronic trading to capitalize on arbitrage trading opportunities to leverage the price discrepancy between the Arrowhead System and the smaller PTS price ticks. Arbitrage trading will likely grow to represent over half of all trading on the kabu.com PTS platform.
(2) What are the implications of the growth of alternative platforms/PTS - On clients?
Since 2009, Japan Consolidated Tape, which displays the best price from multiple markets (traditional exchanges and PTSs) using streams from major information vendors, has become the focus of attention regarding the trend toward a reduction of tick size, including less than 1 yen. While institutional investors are considering using SOR to efficiently execute trades at this best price, the challenges faced include: developing systems (OMS, back office administration, etc.) to link with PTSs, which have not been used until now; the formulation of internal rules and regulations; and dealing with environmental changes arising from greater liquidity in the Japanese equities markets, including PTSs.
- On sell-side firms?
Brokerage houses have focused attention on organizing internal policy governing PTS usage, the pursuit of reduced latency using collocation and the review of whether PTSs represent a viable alternative market trading platform and the capabilities of SOR, such as whether orders can be routed efficiently to multiple markets. From a policy perspective, after the start of 2010 several brokerage houses in Japan have revised their best execution policy to clarify SOR connections to PTSs.
As for settlement cost and counterparty risk, a growing number of firms, including those who previously avoided connecting to PTSs, are now considering using PTSs more intently because the Japan Securities Clearing Corporation (JSCC) will offer clearing services to alleviate these risks from July 2010. On the other hand, in terms of technology, the ability to develop advanced and sophisticated IT systems, including reduced latency networks and direct feeds from the markets, represents a pressing need in the battle for best execution, especially considering prices can fluctuate by the millisecond in SOR.
No stranger to turbulent change, the financial services industry continues to face revenue and cost pressures as well as an increased need to operate globally. Exchanges have merged and relocated, new financial centers and trading venues have appeared, and the market share for incumbent players has declined. Established players have been required to adjust both strategically and operationally to survive in this evolving marketplace. As a result, many firms are rethinking their technological infrastructure and evaluating co-located services.
Demand for fast, reliable and cost-effective technology has grown significantly in the last decade. Reliability and throughput are more important than ever before, and firms that were once content to operate their own data centers or co-locate infrastructure with a financial extranet are evaluating their ability to maintain a competitive position at a manageable total cost of ownership. At the same time, the number of options to consider when determining where an order may be best executed has increased.
As a result, the number of required connection points has grown. In this environment, the ability of network-rich data centers to connect to the various execution venues has made their value more apparent. Bringing together network providers, asset managers, brokerages, exchanges and trading platforms as well as market data and analytics providers, these data centers can dramatically lower the number and cost of high-speed interconnections.
Although data centers owned by network providers currently provide a range of co-location services, they have not proven effective in supporting traffic outside their own network. Increasingly, network-neutral data centers are seen as an effective option for firms pursuing global markets across the evolving financial ecosystem.
Trends in capital markets
As 2009 drew to a close, the Aite Group drafted an impact note outlining what it saw as the most significant trends affecting capital markets in 2010. Drivers include:
Market fragmentation and increased competition, particularly from multilateral trading facilities (MTFs) in Europe and alternative trading systems in the Canadian and Asia-Pacific markets.
Increasing commoditization of high-frequency trading, particularly as independent traders have opened their own trading desks.
Developing a global presence and managing global risk. Aite sees the importance of having a global presence as “one of the key issues for sell-side and buy-side firms.”
Demand for trading infrastructure innovation, including low latency, throughput and support for multi-asset class trading.
Taken together, these trends underscore the important role that technology vendors will play in supporting participants in the global financial ecosystem. At the same time, those vendors are evolving, and the roles they play are shifting to better serve asset managers, brokerages, and exchanges and trading platforms.
The growth of co-location services
The changes in roles for technology vendors started a decade ago, when financial services firms began looking for opportunities to ensure capacity (headroom), improve connectivity, strengthen business resilience and manage costs. Financial services firms typically evolve their use of data center vendors in four stages:
Building a data center adjacent to or in a networked building