Anthony Malakian: FIXating on Cost

I often find myself wondering what the true cost of being the fastest is, and whether it’s worth the headache. In order to be the fastest you need the best trading systems and supporting infrastructure. For those firms directing orders by way of the FIX Protocol, those connections can add latency.

In this month’s feature starting on page 28, I investigated the benefits and risks of brokerages outsourcing their FIX connectivity to third-party providers such as ConvergEx’s ConnEx operating unit, or managing that connectivity internally. It seems to me that the buy-side community isn’t all that fazed with being the fastest—relatively speaking, of course. The race to zero has proven expensive and many are wondering if those expenses are justified. Of course, if you’re a high-frequency trading shop, that is the path you have chosen and you have therefore had to accept the stiff financial demands such a strategy requires.

Threat to Brokers?
When it comes to what she expects out of her broker relationships, Irene Aldridge of high-frequency trading firm Able Alpha Trading, says that if brokers start outsourcing their FIX connectivity, then they may just be lessening their importance in the eyes of their clients. “If brokerages outsource FIX, what of their value-add is left?” she asks.

She says that new rules could make it easier for smaller firms to access markets directly, which could lead FIX connectivity providers to start knocking on hedge funds’ doors. “If I were any of the FIX connectivity firms, I would be warming up hedge funds right now, because many broker-dealers may end up in hot water,” she says.

One need only look at daily volumes on the New York Stock Exchange—which serves as a good barometer to broker-dealer volumes—to see that this is a tough environment for the broker community. So outsourcing certain functions may seem logical, especially for something like FIX, where it’s difficult to prove competitive advantage. Brokers looking to outsource their FIX obligations cite cost savings and redirecting those funds elsewhere, bringing in a workforce that had a true expertise in FIX, or a wholesale need to lessen the workforce in tough times.

“If brokerages outsource FIX, what of their value-add is left?” —Irene Aldridge, Able Alpha Trading

As for the brokers I spoke to that want to rid themselves of their FIX obligations, it was all about cost savings and redirecting those funds elsewhere, embracing a workforce that had a true expertise in FIX, or the wholesale need to reduce the size of the workforce in these tough times. But those firms that insisted on keeping that task in-house chose to do so because they were not comfortable with the idea of ceding control to an outside party. They say that by keeping it in-house, they can more quickly establish new lines, address outages, and—most importantly—reduce latency.

Still, more and more firms are choosing to outsource their connectivity. As with any evolving trend, before there is wholesale acceptance we are likely see more of a hybrid approach when it comes to addressing FIX-related costs, says Anshuman Jaswal, a senior analyst at Boston-based consultancy Celent. “Managing FIX connections in-house can always be an option, but now firms are more inclined to go for a hybrid solution—between in-house and outsourced—or even outsource their connectivity completely. It is advantageous to have more options in an environment where the firm’s profitability is being severely challenged,” he says

Adoption is always a tough sell if clients aren’t happy. And so, as the debate as to how to best address FIX costs continues, there’s no doubt that brokers will be turning to the buy side and asking for guidance. If latency were to dip slightly by moving a broker-dealer’s FIX connections to a third party, or if outages took marginally longer to remedy, would it matter, as long as the firm improves its overall efficiency and offers better services and algorithms?

Cost savings are an easy sell, but having unhappy clients in these market conditions is simply unacceptable. My guess is that the answer to the latency/outage question is “no,” which means that third-party providers will have to prove to the broker community that they’ll never have to put that question to hedge funds.