Fixed Income?

 – Can FIX do for fixed income what it’s done for equities?

While the influence of FIX has spread rapidly in global equity trading markets, its role in broader asset classes has been less vociferous. FIXGlobal asked market leaders, MarketAxess, Tradeweb and Fidessa LatentZero for their views on the impact of FIX in the fixed income arena.

FIXGlobal: FIX4.4 was introduced back in 2003 as a version that provided strong support for fixed income trading. How successful do you feel 4.4 has been?

Bill HaydenBill Hayden (Tradeweb): The adoption of FIX 4.4 was slow at first as people jerryrigged their existing FIX 4.2 engines to handle data for fixed income securities. Over time, however, firms began to address issues such as support and scalability and it became obvious that using FIX 4.2 for fixed income was no longer desirable.

The big wave of adoption for 4.4 came as clients gradually upgraded or replaced their FIX engines. In many cases this was a result of an upgrade or replacement of an existing order management system.

Nick Themelis (MarketAxess): FIX 4.4 was developed to provide realtime, counterparty connectivity for the fixed income community and, since its inception, we have seen strong interest from the buy-side community. For example, 63% of our connected clients access our platform via FIX. We have built partnerships with OMS vendors who use FIX connectivity for their operations, which has further expanded FIX adoption for the buy-side community. We’ve also seen several fixed income ECNs use FIX connectivity.

FIXGlobal: Where the protocol has not been widely adopted, do you feel its been limited by technical strengths or by other business environment issues?

Hayden: In the current climate, the adage of “if it ain’t broke, don’t fix it” takes hold. Firms are not able to make strategic upgrades and are instead forced to switch into a mentality where the primary goal is to keep the lights on.

Another reason that the protocol has not reached a one hundred percent adoption rate is that in many cases fixed income takes a back seat to equities. If a firm is using FIX 4.2 for its equity business then they might not see the incentive to upgrade to 4.4 if the volume of fixed income is small.

Nick ThemelisThemelis: There is nothing technical or conceptual that prevents the fixed income community from adopting the FIX Protocol. There was a legacy investment in proprietary protocols in the early days of fixed income etrading, however as automated trading increases, clients are looking to take advantage of more efficient, more reliable connectivity technology.

Many leading STP tools now support FIX 4.4, allowing for fully electronic interaction across all functions. Pre- and post-trade processes such as order creation, negotiation and trade allocations and settlement can now be fully automated.

Additionally, there are automated, reliable tools available for market participants to get onboard and easily overcome any barriers to entry such as cost or technology development. Greenline’s suite of FIX Protocol solutions and services are designed to ease the FIX adoption process for clients looking to update their legacy systems.

There is growing interest in messaging standards like FIX 5.0 for structured products such as credit default swaps. We have supported CDS etrading since 2005 and continue to offer the technology and access to liquidity for credit etrading.

FIXGlobal: The US has a much more diverse range of fixed asset types than elsewhere in the world, and is typically an over-the-counter (OTC) market. However, some asset types are being offered in a centralized exchange market, such as the NYSE bond market. Do you see this trend towards a centralized market as a way to achieve greater price transparency in the current US economic situation?

Hayden: The primary transaction venue for client-to-dealer fixed income and derivatives trading is likely to remain in the OTC space for the foreseeable future. If we have learned anything in the recent credit crunch it is the importance of the over-the-counter market as credit becomes tight. The primary dealers play an invaluable role in creating liquidity, which leads to lower costs for clients.

The issue of market transparency is also an important driver for the continued role of the OTC model. Due to the very large size of trades, the buy-side is very reluctant to show their positions in an open exchange.

<--break->Themelis: Fixed income is best suited by electronic trading protocols that emulate an OTC market, such as our request-forquote client-to-multi-dealer trading system. The credit market is not well suited to the exchange trading protocol that we see in the equities market where there are continuous two-sided markets all day long.

Furthermore, a trading platform that disintermediates dealers and their liquidity from their clients is not suited to the market structure right now. The advent of TRACE reporting has probably had the greatest effect on increasing transparency in the US for corporate bonds.

FIXGlobal: Where do you see the retail fixed income space relative to the institutional side? With more and more retail-sized clients looking for safe returns by investing in municipal, corporate and TIPS bonds, are your firms working to automate between retail and fixed income?

Hayden: After eight years of operating in the instructional dealer to client space, we launched our Tradeweb Retail platform at the end of 2006. The requirements of retail investors are very different and the system addresses these needs. From day one the retail platform has embraced the use of FIX 4.4. In fact, because of the large number of smaller trades, straight-through processing (STP) is arguably more important in retail than institutional.

Themelis: We see increased activity in the retail sector as clients and regional broker-dealers look for new sources of liquidity. We’ve responded to this demand by incorporating regional dealers onto our trading platform. Regional dealers are typically focused on smaller trade sizes and their participation on the platform has brought much needed liquidity to the fixed income community. The new dealers include independent broker-dealer firms, as well as dealer subsidiaries of regional banks.

FIXGlobal: A tremendous focus has been placed on counterparty risk management since the collapse, or mergers, over the past year of some blue chip financial firms. Real-time position keeping has been of particular interest. Do you feel there is a place for FIX in this risk management process?

Hayden: I think it depends on your view of what FIX is. If you see FIX as a communication tool between two counterparties then I don’t see FIX being implemented for these purposes. If, however, you use FIX internally to connect your various systems such as trading and risk management , then the protocol could be important. In the latter, risk management systems can use FIX to convey position and credit information between internal systems. To this extent it could help customers to manage their counterparty credit. This will be even more important as companies outsource parts of their processes to third party applications that need to interact.

Themelis: Fixed income securities that trade electronically on platforms such as ours help clients update their trading positions more quickly. In the case of corporate bond etrading, executed prices are reported to TRACE in real-time.

MarketAxess’ BondTicker data service incorporates TRACE data into our trading platform to provide real-time corporate bond pricing. Investor clients can use this corporate bond pricing service to run proprietary risk analysis programs. While we offer FIX feeds for our data into any risk management program, additional analysis is ultimately required to derive risk management metrics such as duration and credit ratings.

FIXGlobal: Central clearing is seen with a competitive eye by firms such as NASDAQ (NCC initiative), LCH and Chi-X and EuroClear. What is the impact on international fixed income trading, and what business and technology challenges are firms being forced to address?

Hayden: We view central clearing as being complementary to electronic trading. Our firm is agnostic to the central party; rather we look to work with each of them. We feel that the benefits of electronic execution (speed of execution, price discovery, STP) can be even further enhanced by an electronic link to a central counterparty.

There are technical hurdles that must be addressed with OTC derivatives. FpML has been the defacto standard for derivatives messaging. However, up to now, it has only been used in the post-trade space. Tradeweb has embraced FpML in post-trade, bringing it into the FIX Execution Report message. There are still gaps in coverage with regard to the pre-trade and trade arena.

Themelis: There is potential for the FIX protocol to develop messaging standards for central clearing activities. Incumbents such as the DTCC are facing new entrants into the clearing space as the popularity of credit derivatives is driving the proliferation of clearing opportunities.

MarketAxess supports initiatives that increase transparency and efficiency within the credit markets. Central clearing will significant reduce counterparty risk, thereby contributing to a more sound credit market.

FIDESSA LatentZero join the debate with a different perspective…

Message formats and infrastructure that serve and support cash payments have been very successful. Do you think the market is becoming more motivated to reduce communications costs where real money is not involved?

David BlockerDavid Blocker (Fidessa LatentZero): No. The market, like any other, is motivated by cash control and real, verified savings. Fixed income products trade either short term or long term.

Short term is dominated by new issues where the investor deals directly with qualified institutional borrowers. The long term is dominated by OTC and secondary markets, where there is great variation in the packaging, distribution and consumption of securities. This business is still ‘manual’, conducted over the telephone, and it requires greater effort from operational, legal and management viewpoints. Consequently it will continue to be driven by cash protection and preservation.

The market is also being driven by the need for hard and fast processing-cost reductions. Deploying messaging without an eye toward real costs is not beneficial, either from a business or a technical standpoint.

Fixed income data is significantly more complex than equity data. Do you think the FIX working groups have the experience to deal with fixed income instruments and workflows?

Blocker: The FIX group has been working on fixed income trading since at least FIX4.2. The FIX message tags have gradually been expanded to cater for fixed income specific instrument definition fields and RFQ trading workflows.

This has been an evolutionary strategy and this can be seen in the relatively low volume of fixed income trades currently processed via FIX. It seems there are significant differences in focus between the sell-side (which concentrates on instrument structures) and the buy-side (which concentrates on trading workflows). It might be prudent to separate these two client bases and business disciplines.

Has FIX gone down an equity path that may never work for fixed income?

Although evidence suggests that software that works for one asset class doesn’t work for other, the substance of the messaging infrastructure does not necessarily follow a format specific to a particular asset class. By David Blocker, Fidessa LatentZero, Fixed Income Product Strategist

A well constructed structure, that bears similarity in language and logic to market documentation, trading terminology and events that create messaging content, should be able to suit cross-asset classes and their events as they develop.

FIX has had very active participation from its user community. Is this a sign that, when it comes to anything highly interpretive, technical and complex, a large group of users are the last people who should be involved in the solution?

Blocker: Probably. A small team of practitioners could probably distil a messaging solution from readily available special interest group publications (SIMFA, ISDA, etc) following their regulations and standard practices.

That might create a product with greater utility, breadth and acceptance. It appears from existing FIX participant interactions that the target deliverable doesn’t actually conform to any specific market or practice. It risks becoming a “common denominator” with limited benefit except to those with the time, energy and financial resources to drive the product towards their own particular way of conducting their business.

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