It is a fact that the FIX Protocol generates significant cost savings for the Global Financial Services Community. This fact is further attested by the findings of a recent study, explains Daniella Baker, FPL Marketing and Communications Manager of FIX Protocol Limited.
The past 12 to 18 months sent shockwaves through the very core of our industry. As the world’s financial markets continue to grapple with the impact of the global economic crisis, achieving greater cost reductions and generating increased efficiencies are goals that are riding high on most corporate agendas. During this period the landscape has shifted, regulatory changes have been implemented and new trading practices have emerged. As we move swiftly towards the close of the first decade of this millennium, FPL is proud to release a study entitled ‘The Benefits of the FIX Protocol’, which was produced by Oxera, one of Europe’s leading independent economic consultancies.
Oxera worked closely with Barry Marshall, previous Co-Chair of the FPL EMEA Regional Committee and Jim Northey, Co-Chair of the FPL Americas Regional Committee and Co-Founder of the La Salle Technology Group to deliver the report. The study explores the benefits that flow from the use of FIX in capital markets and amongst other findings, identifies the significant cost savings, reduced operational risk and the longer-term value that greater use of the protocol could deliver in terms of generating increased market efficiencies.
The timing of this study comes at a very poignant point in the history of FIX, as we are witnessing winds of change in adoption. FIX was originally developed as a buyside to sell-side communications tool, however trading venues and regulators across the globe are starting to take note. Listening to their user communities, they too are expressing significant interest and in many cases implementing the protocol.
A prime example of this is the Investment Industry Regulatory Organization of Canada (IIROC) and their plans to offer a new FIX-based market regulation feed specification for market surveillance and transaction reporting.
As the FIX Protocol has developed, its functionality has been significantly enhanced to provide support across the trade lifecycle for multiple asset classes. To put the impact of FIX support into perspective, the study identified that the size of the markets that currently benefit from the protocol now include the USA, Europe and Asia- Pacific equity markets, which in 2008 had an annual turnover of $113 trillion, in addition to a significant number of emerging equity markets; the government and corporate debt securities markets, which had an outstanding value globally of $83.9 trillion in June 2009; the exchangetraded derivatives markets, with notional amounts in the USA, Europe and Asia-Pacific in June 2009 of $63.4 trillion and the global over-thecounter (OTC) derivatives markets, with notional amounts in December 2008 of $591 trillion.
Delivering Actual Benefits So why has FIX proved so popular, what are the real economic benefits it offers to adopters and how can it help to achieve increased market efficiencies?
The study identifies the answers to these questions as lying in the fact that FIX offers a standardised and industry-wide solution. Standards produce ‘network effects’ because as more parties adopt a particular way of doing something, there is greater immediate benefit for new parties that subsequently adopt the same way of doing it, as well as increasing the value to those who have already adopted it.
From a FIX perspective, these benefits translate into reduced connectivity costs as FIX reduces the time and complexity involved in connecting to multiple trading partners across different geographies. Once a firm has made an initial investment in implementing FIX they can then leverage this investment across additional partners. Also, by integrating internal processes and external operations and reducing manual error rates, FIX enables firms to benefit from increased efficiencies and reduced operational risk. These factors in turn can generate greater levels of competition and innovation as switching costs are reduced and suppliers now need to provide improved service levels and more economical alternatives to remain competitive. The diagram below demonstrates the benefits that can be achieved by network effects:
Prime examples of how these factors have delivered actual benefits is the increased number of alternative trading systems now active in the U.S. As commented in the ‘The Benefits of the FIX Protocol’ study this has been significantly facilitated by standardised connectivity solutions such as FIX, because FIX enabled brokers to connect to these new trading platforms for a comparatively small cost.
From a European perspective, when the Markets in Financial Instruments Directive (MiFID) was introduced, neither the directive itself nor the Committee of European Securities Regulators (CESR) addressed the issue of communications standards for electronic trading and market data publication. At this point, many EU based exchanges operated private communications environments with proprietary message formats, which presented significant connectivity costs for users.
However, just over two years after MiFID was introduced, we are now witnessing a similar pattern in Europe as seen in the US, with several new trading venues emerging, including Chi-X, Plus Markets, Turquoise, BATS Europe and NASDAQ OMX Europe, many of which offer FIX connectivity options and present competition to the incumbent exchanges.
Osaka Securities Exchange’s Matthias Rietig reports on the most recent developments in order routing and algorithmic trading in Japanese equities and derivatives.
Upgrades to Japanese Exchanges
Although the Japanese markets have been fully electronic since 1999, last year’s upgrade to arrowhead by the Tokyo Stock Exchange (TSE), as well as Osaka Securities Exchange (OSE)’s move to J-Gate, are quantum leaps in terms of performance. In OSE’s case, the move to faster technology - internal round trip times have been reduced from 60 milliseconds (ms) to below 1-2ms across all derivatives products - also paved the way for a broad revision of trading rules. All Japan-specific rules have been abolished, making way for global standard price/time First-In-First-Out based trading. This will make OSE more transparent and efficient, and hence, a fairer market.
Since Japan is one of the three largest equity markets in the world, the move towards a more globalized market structure, coupled with technology upgrades, will transform Japan into a new hot spot for High Frequency Trading (HFT). That being said, it is important for the exchanges to navigate through this paradigm shift wisely so as to not alienate the domestic user base and very active domestic retail participants. Although TSE volumes jumped about 10% after their move to arrowhead and spreads narrowed, the domestic proprietary trading houses that could not manage the very expensive transition as well as a huge decrease in profitability were driven out of the market, which resulted in a decrease of around 40% in the Japanese cash equity dealer population.
Although we see a proliferation of Multilateral Trading Facilities (MTFs / so called PTS’s in Japan), dark pools and crossing networks and the like entering the market, the liquidity from the domestic layers is still pretty sticky and has an exchange bias. That being said, even in Japan the times are changing and I expect the share of MTFs to increase steadily over time.
With the arrival of Chi-X Japan, all of the existing Proprietary Trading Systems (PTSs) reviewed their business models and it can be assumed that, due to the successful launch of arrowhead and a speed competitive main market, inter market arbitrage activity will rise. Since the Japanese exchanges are already very competitive with their pricing, the battle will be fought over value added services and features, like speed, tick sizes and access options. Overall, a decrease in trading fees can still be anticipated, which should benefit the end users.
While we do see the first signs of new growth of the PTS’s, overall volumes are still relatively small, with TSE capturing roughly 94% of the overall volumes on exchange equity cash trading, OSE about 5%, and the remaining PTS’s command a combined share of roughly 1%. It will be interesting to watch how market structure will evolve with the opening up of the JSCC, which for the first time started to serve PTS’s as a clearing house in July 2010.
Competition will increase, and although Japan is often labeled as overprotective, many domestic market participants believe it is a good development, as competition clearly cultivates services. The government, itself, is committed to induce more competition among markets to gain competitiveness in an international context and re-establish Tokyo as the financial focal point in Asia.
As the equity cash market is increasingly fragmented, the situation in the equity derivatives space is less so. OSE occupies the major chunk of Japanese equity index futures trading, the most prominent being the Japanese benchmark index Nikkei 225, through the Nikkei Mini Futures, which is one of the ten most actively traded index futures contracts, globally． Furthermore, OSE occupies a 100% share in Japanese Equity Index Options.
Although overall volumes went south for most of the other Japanese derivatives exchanges for the last couple of years, trading volume increased for five consecutive years. The newly launched J-Gate derivatives platform in Tokyo aims to make the overall market proposition of Japan more cost efficient and attractive. Located in the same data center as TSE as well as some PTS’s, J-Gate will hopefully benefit from cross connectivity, analogous to the US and European markets.
Smart order routing and algorithmic trading
Smart order routing (SOR) has been gaining traction in the last few years, and the launch of more sophisticated trading platforms, as well as the overall increase of sophistication of the buy-side, should further facilitate this trend. Although adoption by the international buy-side is already relatively widely implemented, the domestic layer has been more prudent to adopt SOR. In any case, it can be expected that the domestic players will catch up quickly, as they are currently screening the market to be ready once the overall liquidity on the PTS’s increases.