The benefits of OMS and FIX protocol for buy-side traders

May 20, 2024

Key Takeaways

  • Although there are different solutions in the marketplace, there is no one-size-fits-all solution for trading cleared derivatives
  • AI has generated a lot of buzz, but the latest versions of FIX order management systems are cutting-edge and effective
  • Integrated solutions for cleared derivatives offer order management, advanced order execution, and connectivity to global markets

Efficiency has always been a buzzword in the derivatives industry. However, pressure has mounted in the face of stronger headwinds. While solutions to create a more seamless and automated marketplace exist, lessons have been learned that they cannot be applied in a blanket fashion to all asset classes.

This is certainly the case with cleared derivatives. The Financial Information Exchange (FIX) messaging protocol has a role to play and has worked wonders for equities and fixed income, but it has not always been a perfect fit for cleared derivatives given their complexity.

More volatility, higher volumes

The focus, though, has sharpened due to a tumultuous four years starting with Covid, followed by a mini banking crisis in the US and the collapse of Credit Suisse and takeover by UBS in Europe. Markets have been further rattled by the ongoing war in Ukraine and the recent conflict in the Middle East, which has widened in recent months. This confluence of events has triggered bouts of volatility due to the fallout of elevated inflation, tighter monetary policy and vacillating economic predictions.

The direction of travel remains unclear, which is partly why asset managers have increasingly turned to listed derivative strategies to mitigate risk and protect against surprise gyrations. However, tailwinds, including product innovation and greater retail participation, have also spurred volumes to new levels.

Figures from the FIA show that the worldwide volume of exchange-traded (ETD) derivatives reached 16.28 billion contracts in February 2024, the second-highest level ever recorded. This was down 2.7% from the prior month but up a staggering 92.4% from February last year. Overall, the final tally for futures and options in 2023 was 137.3 billion contracts, a 64% hike from 2022. This was the sixth consecutive year of record-setting trading activity in the global listed derivatives markets.

However, this was not always good news for the buy-side. The exchanges may have welcomed the business, but asset managers were also exposed to greater operational risk, and process inefficiencies on the back of the greater activity.

In fact, operational inefficiencies and failures, as well as geopolitical risks, were rated as two of the top five main concerns in a recent report by Coalition Greenwich—which canvassed 210 derivative market participants.

Geographical divide

The report noted that weak functionality was a particular issue in most parts of Europe and North America because their ETD businesses were not only high volume and low margin but also operated in mature markets with relatively poor growth prospects. Europe has also been especially impacted by the war in Ukraine because of its close proximity to Russia. In the beginning, the region suffered massive disruptions in commodity supply chains, which caused a significant spike in commodity market turmoil, leading derivatives clearinghouses to increase their margin requirements.

Unsurprisingly, trading these markets for the buy-side has become more difficult. Futures and options may be easier to trade than their OTC counterparts due to standardization, reduced counterparty risks, and better market accessibility, but they require a deeper understanding of market trends and tools to leverage opportunities while mitigating the risks.

Although market participants have increased their technology spending to make trading more continuous and automated, a new study from Acuiti–Futureproofing Derivatives Post-trade: Building Operational Resilience Across the Market–found the majority of the 57 buy- and sell-side firms polled believed that there was more work to do in tackling the pain points and reducing risk.

It noted that almost every facet of the trade workflow required investment. This was particularly true with trade exceptions and breaks, which are still being resolved with manual intervention. AI and machine learning will be instrumental in enhancing connectivity, but as the Coalition Greenwich report points out, the “real game changers” are often much simpler.

The tried and tested OMS in order routing

This could be true of the order management systems, which have been a firm fixture on the investment scene for several years. They have a proven track record in executing securities orders in an efficient and cost-effective manner, though they are not without their challenges, including managing data and testing to ensure they meet a firm’s needs.

However, as strategies have evolved, so too has the OMS, and it is now increasingly being used in multi-asset trading, which encompasses listed derivatives alongside equities and bonds. This has not only provided greater visibility across the trade life cycle of different asset classes but improves order execution and efficiency.

Traditionally, the OMS FIX connections have been the most popular way to route orders, with new technology enhancing the process. More recently, sell- and buy-side firms have been encouraged to adopt a more agile approach to FIX connectivity to improve flexibility, responsiveness, and efficiency in electronic trading. Having a window into how each connection is used has become paramount to help assess the return on investment.

The FIX protocol, which first started in 1992, has become the backbone of global financial communication, enabling seamless trade execution and helping to reduce redundancy and time spent on telephone communications, written messages, transactions and documentation.

The benefits of integration

Market participants have also expanded their electronic trading repertoire and turned to other electronic ways to trade, such as via application program interfaces (API). Integrated solutions for cleared derivatives have also become popular because they have order management, advanced order execution, and connectivity to global markets under one umbrella.

Consolidating onto one service also enables buy-side firms to pursue more complicated synthetic strategies that are executed with algorithms that respond dynamically to instruction amendments and minimize legging risk.

In an operating environment of higher trading volumes, more complex regulatory reporting, and a wider variety of trading strategies, buy-side firms must always have a global view of their portfolio positions to stay compliant and pivot quickly. OMS inefficiencies only increase costs, while investing in a comprehensive OMS system provides lasting benefits and opportunities. Likewise, choosing a broker with uninterrupted connectivity and ultra-low latency is crucial to executing trades effectively. Once those are in place, the opportunities are there for the taking.

ION Markets

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