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Algorithmic trading is on the brink of a new era of standardisation that will accelerate time to market, according to John Goeller, Chair, FPL Algorithmic Trading Working Group and Director of Portfolio and Automated Trading, Merrill Lynch.
Fast Forward for Algorithmic Trading
John Goeller
Virtually all major broker-dealer/sell-side market participants recently announced support for a new initiative around algorithmic trading. Surprisingly enough, the initiative did not involve some new algorithmic trading strategy with a catchy name, the emergence of yet another dark pool or another consortium looking to solve the latest challenge. What could it be you ask? The answer is FIXatdlsm – FIX Algorithmic Trading Definition Language – an emerging standard developed for the benefit of buy- and sell-side firms. And, if you haven't stopped reading at the word ‘standard’, this new language will deliver advanced support for algorithmic trading, enabling buy-side firms, including institutional and hedge funds, to access new order types within a significantly reduced timeframe.
The distribution challenge
The boom in algorithmic trading began in the U.S. equities market in 2000, partly in response to changes in market structure. When the minimum tick size changed from 1/16ths to pennies, it caused a reduction in the spread between bids and offers and forced people to trade in smaller increments. Ideally, to efficiently trade in smaller increments you need to use a computer, hence the expansion of algorithmic trading.
Having a large number of buy-side firms already using the FIX Protocol, the U.S. equities market quickly embraced algorithmic trading as brokers started offering direct access to their algorithmic execution platforms. A key challenge for this direct access was integrating these new execution tools with the client's order management system (OMS). Actually, many buy-side traders had their first experience of algorithmic trading on another trading platform away from their primary order management system.
In most cases, the broker-dealers providing algorithmic trading strategies did not own the distribution channel. An analogy is a new consumer product which needs shelf space next to similar competing products. Shelf space is a valuable commodity, whether that's a supermarket shelf or a buy-side OMS. Most of the OMSs or EMSs (execution management systems) were owned by third-party vendors which meant the broker and vendor had to agree on implementation specifications, along with the not insubstantial contractual/revenue details.
To get around the distribution challenge, many broker-dealers initially purchased a channel in the form of an EMS and eventually a few brokers added OMSs as well. Owning a distribution channel helped as it meant that the brokers’ priorities were always at the top of the development queue. However, buy-side clients use a variety of OMS and EMS solutions, so many sell-side firms still had to create vendor management programmes to handle the variety of business and technical details of distributing algorithmic execution tools.
“… the current method of integration is a very time-intensive process requiring specific development, testing and certification efforts.”
In today's marketplace, buy-side firms are increasingly leveraging the use of algorithmic trading strategies to decrease transaction costs and increase investment return. As a result of this interest, sell-side firms are now competing for the client's attention based on the performance of their algorithmic trading strategies. The current model is for sell-side algorithmic providers to develop a specifications document that reflects the interface requirements of their algorithmic strategies. This requires the OMS or EMS vendors to modify the order entry ticket on their front-end as well as their FIX order-routing gateway to support any FIX tags related to the algorithmic trading strategies.
The specifications document basically describes how to use a firm’s algorithms via the FIX Protocol. It typically describes the strategies, user-defined (i.e. non-standard) FIX message fields and user interface requirements. Unfortunately, every time sell-side providers want to add new strategies (or refine existing strategies) they need to invent new message fields, update their specifications document and wait for the clients/vendors to code it up and release new versions of the user interfaces.
Overall, the current method of integration is a very time-intensive process requiring specific development, testing and certification efforts. From a client/vendor perspective, this issue is multiplied and complicated by the number of brokers they have integrated. Since OMS vendors typically do not release new functionality to all of their clients at the same time, algorithmic providers need to potentially manage multiple versions of their FIX specification document against what the various vendors/clients have developed and certified.
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