The fixed income markets have witnessed unprecedented turmoil in the past few years, which is driving a fundamental change to the market’s structure, its architecture and plumbing, writes Sassan Danesh, FPL co-chair of the global fixed income committee, and managing partner of Etrading Software. While it is true to say that the process of change is still incomplete, one key trend is clear: the rise of electronic trading as one solution to the challenges created by the tsunami of new regulatory and commercial pressures.
The fixed income markets have been volatile in the past few years, with some players such as UBS even exiting the sector. This is driving a fundamental change to the market’s structure and causing many to turn to electronic trading as a possible solution.
However, to meet the hopes that some in the fixed income sector are placing on electronic trading, and to ensure that it can realise its promised benefits, the migration needs to be underpinned by common standards and agreed messaging like the FIX Protocol Ltd (FPL) stipulations – this is the ‘magic ingredient’ I refer to in my title.
Without common standards, each electronic trading venue risks operating in a silo, which will make supplying liquidity to the new post-crash electronic markets much harder for the sell-side, and it will be more difficult for the buy-side to find liquidity in the newly fragmented world, which is being created by the Pittsburgh G20 changes, Dodd-Frank, EMIR, and a host other changes. Furthermore, without common standards, much of the cost benefits of moving to electronic only trading will be lost as the industry is forced to maintain a plethora of different protocols to manage and sustain the market infrastructure.
So what are these common standards, and who is working on creating them?
In this blog, I will explain a couple of the standards being worked on by FIX Protocol Ltd (FPL), the non-profit industry-driven standards body that I work with that is at the heart of the trading community, within its Global Fixed Income Committee (GFIC). I will also explore how adoption of these standards is lowering the industry’s costs, increasing efficiency and preparing the industry for the new regulatory environment:
• The FPL-FIC initiative, a multi-year project to define best practice guidelines for using the FIX Protocol for trading swaps and bond products.
• The FPL-TESI initiative, which stands for Trading Enablement Standardisation Initiative. This is intended to promote an open standard for the enablement of trading relationships between dealers and their clients across electronic trading platforms.
FPL-FIC Initiative: Standardised Electronic Trading
Creation of Swaps Recommendations: The FPL-FIC (Fixed Income Connectivity) initiative kicked-off in June 2011, following the request of a group of leading banks. The initiative brought together sell-side, buy-side, execution venues and ISVs to define an industry set of guidelines for trading fixed income products. With Dodd-Frank in the US and the EU’s Markets in Financial Instruments Directive (MiFID) II looming on the horizon, and their rules mandating the migration of over-the-counter (OTC) products onto electronic platforms, the FPL group set its initial focus on the trading of Interest Rate Swaps (IRS) and Credit Default Swaps (CDS) on Swap Execution Facilities (SEFs) and Organised Trading Facilities (OTFs) in Europe, which are basically everything the EU regulators missed the first time around with MiFID when formulating multilateral trading facilities (MTFs) .
The GFIC group created a four volume set of documents that defined the FIX messages to use for all common SEF business workflows. This document was ratified and released by FPL in March 2012. The guidelines have established themselves as the de-facto standard for SEF connectivity, having achieved wide support in the industry.
Working with other Standards Bodies on Swaps Standards: 2012 saw a parallel initiative under joint FPL and ISDA governance to ensure interoperability between FpML and FIX messaging when sending customised FpML pre-trade CDS & IRS product definitions inside a FIX message. The interoperability guidelines were incorporated into the recommendations documentation produced in December 2012.
Creation of Bond Recommendations: Building on the success of the swaps initiative, GFIC extended the recommendations by creating a new set of best practice guidelines for the bond markets to cover the globally significant bond products, including both governmental (US Treasuries, European government bonds, Gilts, etc) and credit instruments (European credit, Surpas, Agencies, US corporates, etc). The guidelines were officially released by FPL in February this year. While still being relatively new, these bond trading guidelines already have significant support within the industry and will grow and grow.
2013 and Beyond: GFIC is now enhancing the best practices documents to support additional workflows and products, as well as ensuring that the guidelines evolve alongside the pending regulatory requirements. The focus of the working group is to ensure the recommendations can be adopted by all the major fixed income electronic venues.
FPL-TESI Initiative: Standardised Electronic Entitlement
Background: One of the consequences of the 2008 financial crisis is the regulator-enforced transfer of the majority of derivative transactions onto electronic trading venues. This change to the market structure has brought the current process of managing trader entitlement into focus. Today, the process of enabling clients onto OTC electronic trading platforms is highly proprietary to each individual OTC market. It is often ad-hoc, manual and time-consuming and leads to unnecessarily high enablement costs and error rates. These factors suggest the huge potential benefits of an automated and standardised approach to client enablement, especially given that the entitlement workflow is likely to grow significantly with an increase in the number of electronic trading venues. As well as reducing the operational risk currently borne by brokers, defining a standardised approach to trader enablement will also provide the buy-side with a faster and higher quality enablement process.
Launch of the Initiative: The FPL-TESI (Trading Enablement Standardisation Initiative) was launched on the request of a group of banks this February, with the remit of defining an open industry standard for the permissioning of buy-side traders to trade with sell-side banks on dealer to client (D2C) venues. The primary goal of the initiative is to ensure the smooth migration of CDS and IRS trading onto SEFs, although the scope has increased recently to include the trading permissions for the major bond products as well.
Creation of the Entitlement Recommendations: Work on the creation of the recommended practices for the FIX message flows required for setting up and managing trader entitlements is at an advanced stage. The latest draft is now feature complete and will be shortly released to FPL member firms for review, and the guidelines will be made available to the public for implementation in the next few months. This will be done once all feedback generated during the review has been considered and incorporated; then the documents will be formally ratified by FPL. When complete, the guidelines will explain how trading relationships can be established on an automated basis, thereby reducing operational risk and increasing the efficiency of trading enablement on SEFs, as well as on bond electronic trading venues.
Historically, electronic trading within fixed income has been conducted in standalone silos, with each venue adopting proprietary protocols, processes and workflows. Although the recent upheavals within the fixed income markets have caused severe pain, one benefit has been the realisation by the community that common approaches and standards are necessary to ensure the full benefits of electronic trading can be realised by the industry. This is what FPL is working on.
Of course, this does not mean that collaboration should replace competition in all areas. It simply means that common standards provide an efficient platform (‘the magic ingredient’ as I like to call it) upon which market participants can compete and deliver ever more innovative solutions. The work of GFIC group at FPL is clear evidence that the fixed income community has taken this lesson to heart.
Looking to the future, there is no sign that the drivers leading to reduced profitability in fixed income trading are yet abating. To counteract these pressures, the industry has to continue to explore at every opportunity the areas where common standards can be established to drive down industry costs and create efficiency. Fortunately, the years of plenty before the recent turmoil have left the industry with large scope to drive down costs through the extension of standards. I intend to update readers about these initiatives and efforts in future blogs and welcome any feedback in the meantime.
• To contact FPL, one of title’s regular ‘bobsguide bloggers’ please email the messaging standards body that writes on capital markets via the links on the top right of this page, beneath the FPL curator’s biography and picture.