Lisa Taikitsadaporn, of Brook Path Partners and Chair of the FPL Global Fixed Income Technical Subcommittee and Sassan Danesh of Etrading Software chart the evolution of the FPL-FICWG Initiative.
Background and Objectives
In the nearly 20 years of the FIX Protocol standard, the protocol has been synonymous with equities electronic trading and has become the de facto standard used by equities trading systems globally. FIX has evolved over those years to continually support the needs of the global user community across different user groups and has expanded into additional asset classes. In 2001, FIX Protocol Ltd (FPL) signed a memorandum of understanding with the Bond Market Association (which merged with the Securities Industry Association to form SIFMA) to collaborate on enhancing the FIX Protocol to support the trading life cycle of cash fixed income products.
This initiative resulted in FIX Protocol enhancements in version 4.4 of FIX to support additional fixed income asset types, as well as supporting workflows such as quote/negotiation, post-trade allocation and confirmation/affirmation workflows. The fixed income asset types covered in the 2003 release of FIX 4.4 included: US Treasuries, Agencies, Municipals, TBA Mortgages, Corporates, Commercial Paper, Repurchase Agreements and Security Lending transactions as well as their European counterparts.
The release of version 4.4 increased the penetration of FIX into the fixed income space, primarily for buyside connectivity with electronic platforms or directly between buy-side customers and the brokerdealers. However, many of the Electronic Communication Networks (ECNs) active in the fixed income markets did not implement these specifications for connectivity by the broker-dealer community, who provide the liquidity to the markets.
In June 2011, the global investment banking community, with the support of Etrading Software and Expand Research, launched the Fixed Income Connectivity Working Group (FICWG) initiative, aiming to standardize connectivity between major sellside banks and execution venues for fixed income trading through the use of the FIX Protocol and other open industry standards. This initiative was supported by FIX Protocol Ltd. in the same month, and the result was the creation of a working group under the FPL Global Fixed Income Technical Subcommittee to produce the required recommendations to achieve the standardised connectivity.
The initial focus for FICWG in 2011 was standardisation of OTC swaps trading, which was under increasing regulatory scrutiny following the collapse of Lehman Brothers in 2008, and the resulting realisation that regulators required better and more timely information on OTC derivatives trading in order to be able to monitor systemic risk across the market. This realisation led to the mandating of the trading of standardised OTC swaps contracts onto newly established and regulated execution venues known as Swap Execution Facilities (SEFs) in the United States and Organised Trading Facilities (OTFs) in Europe.
By working with FPL, FICWG aims to provide a set of best practices for connectivity between the banks and the SEFs and OTFs using open industry standards in order to enable the speedy, reliable and transparent execution of these swaps trades. The initiative leverages the existing body of work produced by FPL and bond market participants, and extends and updates its scope to meet the changing regulatory environment. In the process of creating best practices, gaps identified in the FIX Protocol, due to evolving market needs, were proposed to the FPL Global Technical Committee for incorporation into the next version of the FIX 5.0 standard.
Addressing the Challenges
In the past five years, Credit Default Swap (CDS) and Interest Rate Swap (IRS) trading has experienced astronomical growth and the 2008 financial crisis highlighted these asset classes as areas of growing concern for regulators – both in the US and in Europe. SEFs were given life by the Dodd-Frank Act in the US which required all standardised OTC swaps to be traded on regulated electronic trading platforms and cleared through clearing houses. Similarly, the European Commission introduced a framework to regulate OTC derivatives – the European Market Infrastructure Regulation (EMIR) – which mandates the matching of buyers and sellers of standardised OTC swaps through OTFs. These regulatory changes will fast-track the evolution of OTC swaps trading onto electronic markets. CDS and IRS trading, have traditionally been negotiated and agreed between parties in a bilateral arrangement, usually over the phone or via email, and with the exchange of ISDA contract terms.
Historically, sell-side firms have connected to fixed income ECNs using proprietary Application Programming Interfaces (APIs) which are expensive and time consuming to develop and support. As a result, integration to new ECNs has been difficult and/or costly for market makers. With the expected increase in the number of electronic trading venues for CDS and IRS, the broker-dealer community has been looking to use open standards to simplify connectivity and increase the array of solutions provided by Independent Software Vendors (ISVs) for connectivity to fixed income ECNs.
The FPL-FICWG initiative addresses this challenge by leveraging established FIX best practices used by other asset classes, including cash fixed income products, to be deployed for CDS and IRS, and to help drive down the cost of connectivity and increase technological innovation based on free, open and non-proprietary standards.
It is expected that the FPL best practices documentation will allow market participants to accelerate their integration to SEFs and OTFs by leveraging their existing FIXbased cross-asset infrastructure and expertise. As the move towards the standardised protocol progresses, the objective is to provide the sell-side with benefits in terms of greater flexibility, lower costs and improved efficiency whilst the buyside, ISVs and ECNs will benefit from reduced costs and complexity.
Working together, FPL and the FICWG approached all market participants who trade, facilitate or support trading of IRS or CDS products. The objectives of the initiative gained industry-wide support, with the majority of the ECNs participating in the FPL-FICWG working group.
The working group analysed the different workflow requirements and common scenarios that exist within the fixed income trading industry. Eight areas were defined (reference data, market data subscription, quote contribution, quotation/negotiation, quote order base, trading, central limit order book and post trade) and more than seventy common scenarios were highlighted.
The working group assessed the capacity of FIX to implement all relevant workflows and scenarios in the different areas and the participants worked to define the best practices guidelines to govern the identified workflows and scenarios. As a result of the analysis, gaps in the protocol were identified and two gap analysis proposals for enhancing the FIX Protocol were submitted to the FPL Global Technical Committee in December 2011 and approved by the GTC Governance Board in January 2012.
The first phase of the initiative consists of a four volume set of best practices documents to be published by FPL by the beginning of March 2012 after the approved gap analysis material has been incorporated. The workflows supported in the four volumes include:
1. Security definition and reference data requests
- Dealers can request and subscribe to securities traded on the SEF.
- Dealers can submit a security definition to the SEF and be provided with an identifier for that security.
- Dealers can request the trading status of a given security.
The working group participants made a deliberate decision to base the instrument definition requests and identification flows on established conventions used by the listed futures market. The ability for dealers to submit a security definition to the SEF provides flexibility in this evolving market where securit attributes may to be adjusted to accommodate trading needs.
2. Pricing data subscription
- Dealers can subscribe to market data prices from the SEF.
3. Contribution of prices to the market
- Dealers can submit quotes into the market for distribution to customers.
4 Quote/Negotiation dialog
- Dealers can respond to directed quote requests from customers through the SEF.
- Dealers may engage with the customers in a negotiation workflow, where countering is possible if the customer chooses to negotiation with the dealer.
5. Hit/Lift and negotiation of submitted quotes
- Dealers receive response against quotes that are contributed to the market.
- Dealers may counter the quote and negotiate with the customer through the SEF.
- Dealers may confirm execution of the quote.
6. Central order book flow
- Dealers submitting orders into the central order for matching
- Dealers receive fills report for matched orders
For readers knowledgeable of the futures market, several of the workflows above may be familiar, particularly the securities definition and reference data request workflows, market data subscription, and quote contribution and the central order book workflows.
As with any initiative that strives to use an existing standard to support new markets, gaps would inevitably be identified. As a result of the efforts put towards the best practices for using FIX for CDS and IRS trading, two main gaps were initially identified. The first is a gap in the message flows related to quote/negotiation, where there was a requirements from the quote providers for the SEF to provide explicit acknowledgement of the submitted quote prior to customer response. This is illustrated in Figure 7 below. The second enhancement to the FIX Protocol was a proposal to enhance the existing InstrumentLeg component to include the ability to carry an XML payload. The proposal was for an instrument leg level equivalent to the existing SecurityXML component that is in the Instrument component. This new LegSecurityXML component would allow for the use of XML description of the security in each leg of a multi-legged security.
The leadership shown by FPL and the FICWG members alongside their willingness to adapt and evolve with regulatory reforms has already shifted the swaps landscape towards acceptance of open industry standards. In the last year, the leading fixed income SEFs agreed, over time, to implement their API protocols in FIX and many have expressed an interest in adopting the best practices recommendations. This in itself is a significant achievement for FPL, FICWG and the open standards community.
In light of this success, for Phase 2, FPL and FICWG are looking to continue to extend the scope of the initiative to cover:
•Additional attributes such as duration-based strategies
•More specialised workflows such as workups/volume clearing
Plans for 2012 also include a separate initiative to create a similar set of best practices guidelines for the cash bond (government and credit) markets. This new initiative will leverage existing best practices already established between bond trading platforms and the customer side, as well as the best practices documented for CDS and IRS electronic trading.