FIX Protocol Offers Connectivity Solution for Some, But Not All SEFs

In the second of its three-part report on SEFs, the consultancy and research firm has determined that while functionality exists within the standard for an easy adaptation to the utilities that are more similar to equities-based functions, others will find a more unique solution is required.

"There's already a large push towards FIX by the industry in general, and particularly by sell-side banks, which are looking to minimize their technology spend," says Bradley Wood, managing parter at GreySpark. "It's definitely a hard-and-fast requirement. All of the venues that we spoke to, to varying degrees, made a commitment towards FIX in cases where they weren't already there. It's pervasive, and it's a fait accompli that they'll be trying to do that. I think the challenge comes when it's not an order book-based SEF, but an RFQ-based SEF as the latter has a much more complex execution model that is not that easy to implement over FIX."

Idiosyncrasies
For order book-based SEFs, the workflow functionality of placing an order and returning the execution, says GreySpark, is relatively simple, even if there may be fine-tuning required around reference and market data functionality. RFQ-based SEFs, however, work on a more complex series of interactions that do not necessarily conform to standardized protocols.

"The nature of a quote-based market is one of a series of negotiations that occur between the dealer and a prospective client, or multiple dealers and a client that has requested a quote," Wood explains. "There's a negotiation function where an RFQ message is sent, the response is sent, then the dealer has what's known as a last look, where they reserve the right to change the price, or the quantity, or some other parameter. All of this means that the interactions between buy side and sell side can become quite complicated, particularly when you factor in the vagaries of last looks and firm prices versus indicative prices, for example. These complexities mean that the FIX protocol, the message formatting and the payload that the protocol can support is not very well-suited to that negotiation element, which is specific to a quote-based dealer-to-client platform."

The idea is best expressed as a series of state changes, where a participant will move quickly between various positions in the deal. These can be anything from waiting for a price, receiving an indicative price, modifying terms all the way through to execution. FIX as a protocol was originally designed for equities markets, lending itself well to organized workflows. With RFQ-based platforms, however, a move to proprietary application programming interfaces (APIs) may be necessary at first.

We have spoken to some venues that have indicated an intention to offer co-location and sponsored access services once the regulations have been ironed out.

This may not be the ideal outcome. Recent industry initiatives such as the Fixed Income Connectivity Working Group (FICWG) have aimed to minimize the level of custom APIs used in connection to utilities such as SEFs due to the fact that they can be costly and laborious to implement. However, given the level of functionality required for the negotiation-based approach, larger venues with established APIs, such as Bloomberg, see them as offerings that more adequately meet the needs of the trading environment.

SEF Co-location
The move to electronic, on-exchange trading of standardized derivatives, as mandated by the US Dodd-Frank Act, is almost certain to increase volumes. Others believe that the organized approach and shift from over-the-counter and voice-based trading will also give rise to considerations of latency, direct market access (DMA) and other areas. As part of this, SEF co-location is actively being explored by venues.

"In theory, you could have a hedge fund, a traditional buy side, connecting directly into an interdealer broker platform," says Wood. "In cases like that, it's entirely within the realms of viability that those hedge funds, for example, could choose to use sponsored access, DMA, co-location type services where they're made available by SEFs or prime brokers. We have spoken to some venues that have indicated an intention to offer co-location and sponsored access services once the regulations have been ironed out."

The Bottom Line

• While FIX is suitable for order book-basis SEFs in certain asset classes, RFQ-based SEFs will find that the negotiation process is difficult to represent at present in the protocol.
• For these venues, traditional, proprietary APIs still offer the best functionality for market participants, despite industry drives to minimize usage due to cost and time.
• As the electronic swaps market develops in the coming months and years, prime brokers and SEFs themselves may begin to offer DMA and co-located services for latency-sensitive operations.