FIX For All
By Kevin Covington
April 14, 2004

Summary: If a secure, cost-effective communication infrastructure using FIX could be made available, the result would be cheaper order flow for smaller buy-side firms, and STP rates would increase. By Kevin Covington.

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The problem of buy-side adoption of technology that supports greater levels of STP – and specifically FIX – will be familiar to most readers. The remedy usually proposed for the slow uptake of automation among small and medium buy-side firms has been to make it cheaper. This has traditionally been done at the expense of the sell-side or through the provision of limited functionality solutions.

Sell-side firms have previously subsidized the adoption of FIX within key buy-side clients, but this practice is waning and does not extend to the smallest buy-side firms. There is also debate on the sell-side as to whether it is best to be the first broker a buy-side firm communicates with using FIX. Particularly with subsidized implementations there is the risk that, after all the teething problems, other brokers will come in and benefit from the electronic order flow that has been established. Additionally, forthcoming regulation from the FSA touching on softing, bundling, price discovery and best execution will make compliance officers turn their attention to subsidized implementations and the impact they have on order routing decisions – to protect the ultimate owners of the funds under management.

In general, buy-side firms currently have good relationships with their brokers and are primarily happy with processes as they stand. However, with the new regulation in mind, they should take the time now to look at their operations and discover where any inefficiencies exist.

The EU Commission’s proposed revision of the Investment Services Directive is likely to have a major impact on the investment management community, especially as it filters down to country-level regulators like the UK’s FSA. One major issue which has been the subject of consultative papers by the FSA, and mentioned in others regarding softing and bundling in the industry, is best execution. Part of the best execution prerogative entails having a choice of liquidity pools to access, either via a broker or direct market access. It also entails making this access as efficient as possible – something that FIX automation addresses.

But when forced to go it alone, a small hedge fund with low capital expenditure, possibly running off a spreadsheet with a portfolio management system at the back, just can't afford a key STP enabler – namely, the investment in FIX. They don’t necessarily need a large OMS platform, but even installing a FIX engine to get electronic order flow through to their executing brokers, or other liquidity pools, might seem too expensive. Not to mention that in order to guarantee a fully compliant FIX dialogue with counterparties they would have to maintain as many point-to-point connections, via a VPN or leased line, as they have counterparties – adding hugely to cost of access, maintenance, monitoring and particularly the cost of managing that infrastructure. This FIX deployment model – let’s call it the ‘DIY model’– was conceived at a time when the markets were at their highest for decades, hence the high cost of ownership and maintenance, and the not surprising limited take up by tier-two and tier-three firms.