As swaps trading became mandatory on electronic platforms earlier this year, most SEFs began rallying around a de facto standard, which turned out to be the FIX Protocol.
Last week, FIX Trading Community, the non-profit, industry-driven standards body, announced that FIX had been adopted by the vast majority of swap execution facilities, including BGC Partners, Bloomberg, trueEX, GFI Group, ICE Swap Trade, MarketAxess, Tradeweb (TW and DW), Tradition Trad-X, and Tullett Prebon.
This is not a complete list of the SEFs using FIX, since the FIX Committee focused on those SEFs trading interest rate swaps and credit default swaps that had gained reasonable traction in terms of volumes. [One major SEF not on the list is ICAP, though the firm supports FIX for its other trading venues.]
Rather than insist on proprietary protocols to set their platforms apart, SEFs have adopted FIX, which has made connectivity easier for buy-side and sell-side firms. This in turn will lower the cost of trading and connectivity for market participants.
“There has been an acceptance within the industry that connectivity is an area that it doesn’t make sense for the industry to compete on, and therefore it no longer makes sense to have proprietary protocols or one protocol that is better than another,” says Sassan Danesh, co-chair FIX Trading Community Global Fixed Income Subcommittee and managing partner of Etrading Software.
“Within that SEF world, that is simplifying connectivity and allowing the industry to tap liquidity easily, which is actually a benefit to everyone. Actually it’s a win/win on top of which individual SEFs can define their own unique business models rather than compete on connectivity,” says Danesh.
SEFs were cautious about moving to the latest version of FIX, 5.0, which is why it was back-ported to the common versions, 4.2 and 4.4, he notes. However, they approached their clients and they found that most clients didn’t have much problem migrating to the current versions. The trend is a sign that SEFs are focusing on integration with their market participants, the benefits of lower trading costs, and access to liquidity.
“This has been a big mind-shift in the OTC markets,” he says. “That shift in thinking occurred over connectivity to SEFs, because nobody knew which SEFs would gain liquidity. From a buy-side and sell-side perspective it made sense for technology to tap liquidity wherever it resided.”
This approach minimized the constraints of the technology on teams talking about why their own business models were better. Instead they focused on more of a partnership with the industry. For the SEFs, it made sense to have the discussion with the key liquidity providers and takers on the benefits of their own business model, and not to have to worry about the constraints of technology stopping them from connecting.
Don't worry about fragmentation
One of the early concerns has been the proliferation of SEFs and whether this would lead to fragmentation of liquidity in swap instruments.
“I think we shouldn’t worry about it fragmentation. I think we should embrace it as an industry,” says Danesh. “Surely it is bad, and causes ripples in terms of price discovery. Far more important than worrying about fragmentation and looking at creating a single venue of pools for all the liquidity is to construct a market architecture that allows a fragmented marketplace that still allows productive price aggregation,” he says.
Instead of attempting to construct a single venue of multiple pools of liquidity, the point is to construct a market architecture that allows for price aggregation and smart order routing, he says. While there are challenges in US equities markets, with 12 public exchanges and 40-plus private trading venues, one thing would be to have an aggregated market -- and the sum of all markets is the individual liquidity pools, he says. Participants can hit whichever market has the best price at a certain point in time. That model won’t come across in the same format in the fixed income world, but standardized connectivity will enable liquidity to be aggregated, suggests Danesh.
“The aggregation occurs today in which SEF has the best liquidity and where is it and to what depth. All that can be built today using commoditized tools that have been built in other asset classes,” he says. For example, a US 5-year interest rate swap is the same product across all SEFs, which is the premise of the Made Available to Trade rule, requiring an instrument to trade on SEFs. It’s the same product, and the aggregation tools that have worked in other asset classes can be applied to swaps, he suggests. Different swaps could end up building liquidity on different SEFs, such as benchmark IRS trading on one platform, CDS indices on another, and high-yield vs. high-grade CDS on still others.
As far as smart order routing applied to swaps, in the wholesale market the ticket sizes are higher than equities. But the smart order routing concept could apply more as the number of tickets goes up and the ticker sizes go down, he notes.
Fragmentation has another advantage, according to Danesh. “What I really like about that market model, is it allows for innovation to be much stronger than if liquidity had to be concentrated on a single venue,” he says. In a market where fragmentation can occur, it allows for new entrants “with a brilliant idea” to come in and grow their franchise and take market share from people not updating their products.Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio