EVOLUTIONARY CHALLENGES.

With everyone scrutinising the launch of SEFs in the USA, Daniella Huggins* explains the importance of developing industry-wide standards, and why initial guidelines published earlier this year by FIX Trading Community are critical in addressing the business challenges facing OTC Derivatives and fixed income markets.

As global regulatory reforms push the vast OTC derivative markets onto electronic trading platforms, this autumn will witness the achievement of a major milestone with the launch of the new Swap Execution Facilities (SEFs) in the USA, significantly changing the way these products are traded and the structure of the market itself. This development is likely to be carefully monitored on both sides of the pond, in the hope that it will provide an indication of the future shape of the European markets once the rules pertaining to proposed Organised Trading Facilities (OTFs) in the EEA (European Economic Area) are finalised.

With an estimated 40-50 SEFs planning to launch, the prospect of sourcing liquidity across this newly fragmented marketplace presents concerns. Without an early indication as to which of these platforms will be highly liquid, broker-dealers face the technical challenges and financial implications of potentially needing to access multiple competing venues in an efficient manner.

These developments will impact many of the 275+ member firms of FIX Trading Community, the non-profit, industry-driven standards body at the heart of global trading, and so its members have been working together to help firms industry-wide to manage the implications of these developments on their businesses. Much of this work has focused on enabling market participants to connect to the new SEF platforms using standards such as the FIX Protocol, which is used by thousands of firms every day to complete millions of transactions. The opportunity to do so presents the potential to achieve greater cost-efficiencies for all market participants, including the buyside as well as the sellside.

FIX adoption by trading venues around the world is on the rise. Most of the MTFs (Multilateral Trading Facilities) in the EU that were created as a result of the new competitive environment introduced by the MiFID regulations in 2007 have chosen to offer FIX access to their users. Using the same standard made it easier, quicker and less costly for new users to have access, and also made it easier and quicker for new MTFs to penetrate a market where investment firms are already not only huge users of FIX but are also the firms that drive the development and adoption of FIX. The potential for investment firms and SEFs to achieve similar positive results in the fragmented OTC Derivatives markets is proving to be highly appealing.

Work in this direction by representatives of the proposed SEFs and the broker-dealers that wished to connect to them began in 2011 when they came together to work as part of the FIX Trading Community Global Fixed Income Subcommittee to develop guidelines on how FIX could be used to trade swaps on the new SEFs. At that time the Dodd-Frank rules were still in a state of flux, but the group knew that Credit Default Swaps (CDS) and Interest Rate Swaps (IRS) would need to be traded electronically and so began with these. This led to the publication by FIX Trading Community in March 2012 of an initial set of guidelines explaining how CDS and IRS products could be traded using FIX, and at the same time the specification of FIX was enhanced to ensure that it could meet the identified business needs. These guidelines were rapidly adopted by proposed SEFs as the recommendations helped them to begin building core infrastructure that would enable easier access for their users. The relevance and success of these guidelines and FIX standards is demonstrated by the fact that almost all SEFs set to launch in the coming weeks are planning to offer FIX access.

FIX was already enhanced earlier this year to enable firms to meet the CFTC’s regulatory reporting requirements related to swaps data repositories, end-of-day positions, large trades and margining. As the Dodd-Frank rules became clearer and more prescriptive, the group further enhanced the FIX standard, and FIX Trading Community released updated guidelines in September 2013 explaining how FIX can be used to trade the wider range of products now covered by these rules. These updated guidelines also include recommendations for how FIX can be used to support different permutations of cross-asset trades; how it can be used within the fixed income market; enhancements to meet new regulatory developments including the Central Counterparty Clearing House and the Legal Entity Identifier (LEI) initiatives; as well as support for the electronic booking of voice trades.

And the work did not stop there. To trade on a SEF on behalf of a client, key information about that client’s relationship and their associated permissions must first be logged. Without a standardised electronic approach, broker-dealers would face the possibility of this information being requested by SEFs in different ways by the various platforms, requiring significant administrative work and even manual reporting. The new guidelines, which have been recently released, demonstrate how this business process can be carried out in an electronic, automated and standardised manner, presenting the potential to further reduce operational risk and generate considerable efficiency gains and cost savings for market participants.

FIX Trading Community’s work will not end here – further projects are already underway addressing the business challenges facing OTC Derivatives and fixed income markets. To accommodate just the recent regulatory and market changes that have taken place to date the FIX specification has almost doubled in size and with so much regulation in the pipeline the possibility of it expanding even further is looking rather likely!

*At the time of writing Daniella Huggins was global marketing and communications manager at FIX Trading Community.