George Macdonald, CEO of Macdonald Associates (MACD) looks into the history of German exchange platforms and reveals the future of German exchange connectivity through FIX.
Germany was slow on the uptake of FIX. In order to understand that statement, it is necessary to take a look at the past. It was not because they were slow at adopting electronic trading, but in fact, precisely the opposite; the Swiss Exchange (then called SOFFEX) and the German Exchange (then called Deutsche Termin Börse) were right at the forefront of electronic trading with their systems going live at the end of the eighties.
Electronic trading took time to gain significant momentum. In 1996 the BUND (a futures contract on German debt) was still traded almost exclusively in London at LIFFE in open outcry. The fully electronic German exchange, despite having been around for six years, had managed to gain only 30% of market share. Indeed, many people at LIFFE believed that derivative trading could never move off the floor and onto an electronic platform. The move to Frankfurt happened in stages, with intense competition at the end of 1997. However, once 50% was reached, the tipping point had occurred and the volumes migrated entirely in just a few months.
The Germans had demonstrated that electronic trading could work. The cash market for equities was also one of the first to move to a fully electronic platform, with the Deutsche Börse order books going live on Xetra in 1997. Since then, electronic trading has swept the globe, with almost no market resisting the inevitable change. There have also been a lot of other changes since then as the trading process continues to evolve. The early success was also the reason for the slow uptake of FIX; the first mover advantage on electronic trading meant that the exchanges and banks built a trading landscape tightly knitted around a small number of proprietary systems.
Ultimately, two main connections to liquidity evolved: Xetra, a proprietary trading platform developed by the Frankfurt exchange, and XONTRO, a system which connected the banks to the regional exchanges (Stuttgart, Düsseldorf, Hamburg, München, Hannover, Berlin and the Frankfurt floor). These two systems ensured that the trading landscape became intertwined and dependent on the existing infrastructure. There was no pressing need for a change. This, in turn, made it very difficult for new entrants such as Equiduct, NASDAQ Europe and Chi-X to gain a foothold. The move to FIX was something inevitable, however, and it was only a question of when, not if, the connectivity changed.
Gradually, some new exchanges did experience success. For example Tradegate, a new startup exchange based in Berlin, has recently been successful in capturing flow, using FIX as their main method of connectivity. Thorsten Commichau of Tradegate said: “FIX is basic technology that makes sure your order stream doesn’t dry up. We at Tradegate have been providing it since 2001 and recently an increasing number of other German exchanges have started to use it too. Tradegate’s FIX interface supports modern order types such as one-cancels-other and trailing-stop limit and has made proprietary access alternatives unnecessary. In 2010, Tradegate Exchange recorded 3.2 million trades, a growth of 33 percent compared with 2009. Nowadays, over 80 percent of all customers send their orders to Tradegate Exchange in the FIX format.”
Hanno Klein of Deutsche Börse has also been actively involved in FIX for many years, serving as co-chair of the Global Technical Committee (GTC). As a part of the GTC, he has also been very active in ensuring that FIX 5.0 includes functionality required to cover trading on an exchange and makes some of the FIX verbosity related to message flows optional. For example, some execution reports can be implicitly dropped because they are redundant, and partial fills can be bundled into one message, thereby enabling an exchange transaction model to be modelled in FIX (for more details see volume 7 of the latest FIX specification).
Of course, there are some banks who have been using FIX for much longer. One notable example is Baader Bank. As Edward Strauss of Baader said, “FIX continues to be a key standard in our inbound and outbound connections at Baader Bank, with the number of connections growing exponentially. In 2004 we had four FIX connections and now have over 100 FIX connections. As the protocol expands, Baader is becoming quicker in being able to take advantage of new innovations in finding solutions for connecting to our customers. I foresee that this trend will continue”. But the number of banks using FIX is still far fewer than one would expect for a market the size of Germany. The uptake is most common amongst large banks and those that trade with foreign counterparties. Until recently, the vast majority did not have any FIX implementation at all and continued to use SWIFT, other protocols, or the telephone for trading. All this will finally change when Deutsche Börse makes a sweeping amendment to their current connectivity offering in Q4 2011, bringing in a new interface using FIX that will, over time, phase out their legacy infrastructure.
The Börse says “The new FIX Gateway for Xetra and Eurex will allow customers to use a well-known, international standard protocol to access our trading services. Eurex already offers FIXML access to risk management services. We see an increased demand for FIX-based services for both Xetra and Eurex customers and have made a strategic decision last year to move in this direction.” In a further significant change, the exchange will move all floor trading to the Xetra platform, revolutionising the Skontroführer system in Frankfurt and making wide ranging changes for the broker managed stocks. At the same time, XONTRO is in the process of adding a FIX interface to their network, thereby providing banks with an alternative to the previous proprietary connection. For the first time, it will be possible to access all German liquidity centres using FIX. This will, inevitably, be the biggest shake up to the trading landscape in Germany for more than a decade.
Changing connectivity is more than just a change to the messaging protocol; changing the plumbing makes other developments possible. Connectivity becomes a commodity and accessing new liquidity pools is suddenly much simpler. This encourages new entrants to enter the market, which in turn offers banks a greater choice of trading venues and software solutions. In time, the process becomes self-perpetuating.
Over the coming year, banks will be reviewing their existing connectivity setup and will need to make alterations in preparation of the upcoming changes. There will be an increase of hosted connectivity, and access to trading networks, offering banks the ability to tap into multiple sources of liquidity with one single connection. Also, alternative exchange venues will once again try to make inroads into the German market. Using FIX, access to dark pools will become easier and banks will look to connect to different destinations to source the liquidity that they require. Finally, there may well be a shake-up in the offerings from the regional exchanges, as they try to compete for customers and re-define their business models.
Of course, no change happens entirely overnight, but the evolution over the next few years should not be underestimated. The next 18 months are going to be very interesting in Germany.
The German Connection
