Martin Sexton of London Market Systems Limited examines the benefits of the SKOS network for product classifications.
Being top of the game is the aim of any trade association and FIX members are not scared of putting their heads above the trenches when it comes to identifying a clean and simple solution to an industry issue. Not only has a proposal been put forward that meets the OTC derivative products reporting requirements associated with Dodd-Frank, but it is also working with others such as ISITC and X9 to create a viable solution to meet the need for a globally acceptable classification scheme under the ISO banner. There is an overlap between these two initiatives in that financial products need to be appropriately classified; and this is where semantics has a role to play.
As soon as ontology is mentioned a concern is always raised as to the potential impact on a project due to the risk of adding latency into the deliverable time line. There is the impression that any semantic analysis is complex and yields little in tangible benefits. So what is the missing link? Could it as simple as identifying a framework capable of linking a semantic model onto a physical model?
Simple Knowledge Organisation System (SKOS) is just that framework; it allows the user to provide meaning and understanding to financial product classifications and, where appropriate, a visual representation can be used to help convey its intended use and ensure the industry exploits its capabilities and achieve maximum potential.
If we take the recent FIX Protocol regulatory reporting proposal, SKOS allows us to link the FIX terms with those outlined in the final rule (17 CFR Part 43 - Real-Time Public Reporting of Swap Transaction Data). ISDA for their part has developed a set of taxonomies. Based on four key terms the strict hierarchy under each asset class comprises three related terms, namely Base product, sub-Product and Transaction type. A further extension to this scheme is provided for commodities to support the Settlement type (this can have the value “cash” or “physical delivery”). The FIX proposal covers all asset classes and base products whilst the ISDA proposal only focuses on OTC derivative products.
The CFTC Rule identifies two key facets, namely asset class and contract type, each of which can be broken down further by sub-asset class and contract sub-type respectively. SKOS provides the ability to manage the relationship between all the terms and most important link them to the associated FIX equivalent tags.
At a high level the relationships between the CFTC’s final rule, the FIX and the ISDA proposals can be represented in a diagrammatic form.
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.