Trading systems of the type used in foreign exchange to aggregate prices from multiple dealers and venues are increasingly sought after in fixed income markets, where direct streams and upstart execution platforms are starting to fragment liquidity.

For tech vendors, already facing scrutiny of their activities and fee models in FX, expanding into fixed income may be a case of ‘out of the frying pan and into the fire’.

The European Securities and Markets Authority (Esma) is currently investigating claims that some execution management systems (EMSs) in FX are de facto trading platforms, and should have to register as multilateral trading facilities (MTFs).

It is harder to make those charges stick in spot FX, which falls outside the scope of Europe’s second Markets in Financial Instruments Directive (Mifid II). That is not the case with fixed income. “In FX, there isn’t a requirement on the buy side that they must trade on an MTF,” says Vikas Srivastava, chief revenue officer at Integral, an FX technology provider and e-trading platform. “In fixed income, the onus might be on both sides. In that case, platforms should offer their EMSs as MTFs.”

The fee models of EMS vendors have also come under regulatory scrutiny. While some charge a fixed software license fee, others charge volume-based commissions, or both.

The UK’s Financial Conduct Authority (FCA) has been discouraging the use of volume-based charging models as part of a wider crackdown on payment for order flow. Some of these fee arrangements may also breach Mifid II rules on inducements and conflicts of interest.

A trading technology expert familiar with several EMSs sums up the problem with commission-based fee models: “The asset manager pays [a] commission to the dealer, which is perfectly legitimate. But some of those commission payments may get kicked back to the EMS and used to subsidize the cost of the technology the buy side is using. That’s an inducement.”

The head of trading at a large hedge fund says EMS vendors should be more transparent about their charging models in general. While volume fees are common in many markets, he says regulators should investigate whether some vendors are engaging in anti-competitive or abusive practices.

For their part, EMS vendors say they are being stifled by fixed income venues, some of which block them from executing orders via application programming interfaces, or APIs. That makes the question of whether they need to register as MTFs moot, for now. But as EMSs look to replicate their models in equities and FX, more scrutiny seems likely to follow.  

Bumper charges

Buy-side firms have long used EMSs to access multiple venues and direct price streams in FX markets.

There is less need for these systems in rates and credit, where dealer-to-client liquidity has historically been concentrated at a handful of request-for-quote (RFQ) venues, such as Bloomberg, MarketAxess and Tradeweb.

This is changing. A number of new venues—including LiquidityEdge, Liquidnet, OpenDoor Trading and Trumid—have entered the field in recent years, some offering new ways to trade. Dealers have also taken a leaf out of the FX playbook and started streaming liquidity directly to clients. The established venues are responding by rolling out new execution methods, including dealer streams and portfolio trading.

All of this has piqued interest in EMSs. “If you look at fixed income, the liquidity is now fragmented across many platforms,” says Michel Lansink, head of trading at fiduciary asset manager Cardano. “It would make sense if an EMS could provide an overall view on available prices and liquidity across those platforms, and offer the opportunity to transact and access these venues directly within the EMS ecosystem.”

EMSs perform a number of functions. They provide connectivity to venues and liquidity providers and aggregate prices to create what is effectively a single order book for execution. In some cases, a trade can be initiated and executed within the EMS itself, without interacting directly with the platform. 

The question is how these services should be paid for and regulated.

In equities and FX, it is common for EMSs to charge volume-based fees. “I’ve looked at three or four firms that work on the commission-based model,” says the chief executive of a fixed income EMS vendor. “They are always different, but the main components are a fixed user fee [and] a volume-related commission based on trading.”

It would make sense if an EMS could provide an overall view on available prices and liquidity… and offer the opportunity to transact and access these venues directly within the EMS ecosystem

Michel Lansink, Cardano

Some vendors layer additional charges on top, he adds: “When it comes to exotics, there can be another fee based on the type of instrument and volume, and a fee per trading venue.”

Critics of volume-based charging argue it is fraught with conflicts and open to abuse. The FCA has been discouraging the practice of platforms collecting commissions from dealers on trades they facilitate as part of a clampdown on payment for order flow. If a payment model unduly influences routing decisions, or if dealers are found to be paying vendors for services provided to clients, this could fall foul of Mifid II’s rules on inducements, best execution and conflicts of interest.

Medan Gabbay, chief revenue officer at EMS vendor Quod Financial, says volume-based fees can also skew competition among dealers. Some vendors offer volume discounts to the sell side, he says, which can reinforce the dominance of larger liquidity providers.

“The effect of the preference is that that one bank’s cost basis could be, for example, 25% higher than another’s on any individual client. Therefore, they have the ability to win more business. That is a problem,” says Gabbay. “It’s not that the platforms are specifically discriminating against particular banks, but the nature of their pricing models are based on cumulative business rather than per client business. It makes it very difficult for smaller banks to be competitive, particularly in niche currencies.”

Joey Horowitz, chief technology officer at Tradepoint Systems, an FX trading technology provider, confirms the practice. “The preferential treatment that we sometimes hear about is based on brokerage models, where some of the bigger banks who do the most volume have volume-based discounts. Our aggregator model charges the buy side. Liquidity providers don’t pay.”

It’s not that the platforms are specifically discriminating against particular banks, but the nature of their pricing models… makes it very difficult for smaller banks to be competitive, particularly in niche currencies

Medan Gabbay, Quod Financial

In light of these issues, some EMS vendors—such as Axe Trading, SmartTrade and TradingScreen—are steering clear of volume-based charges in fixed income, opting instead for a flat software fee.

“We entered the FX market with a flat technology model a long time ago,” says Annalisa Sarasini, chief business development officer at SmartTrade. “What we’re seeing is people now want this on the fixed income side as well.”

Ivan Mihov, head of buy-side fixed income solutions at Axe Trading, says the ‘dealer pays’ fee model common in equities and FX is out of place in fixed income. “It does not match how firms want to pay for their fixed income technology,” he says.

Joseph Ahearn, head of fixed income at TradingScreen, has “little appetite to get in the middle and get some sort of volume-based fee”. He says: “Really, it’s about selling the software license to access those liquidity points.”

The trading technology expert says EMS vendors should stick to charging software fees if they don’t want to be regulated as broker-dealers.

“If EMSs want to argue they are technology providers only, their charges should be bandwidth related, so an EMS charges a bit more for monitoring services, for management of the line to help with any issues, not based upon the nominal value of the trades.”

Access denied

Questions about fee models are not the only ones surrounding EMSs.

In addition to aggregating liquidity, several EMSs for equities and FX also allow buy-side firms to execute against live prices and initiate RFQs within their systems. Some regulated venues argue EMSs offering this sort of functionality should be forced to register as MTFs.

Esma and the FCA are understood to be looking into the issue.

This is a simmering issue in fixed income. EMS vendors complain some venues are blocking API access to their execution engines.

Four sources put fixed income venues operated by Bloomberg and Tradeweb in this camp. 

Abdullah Hiyatt, chief executive of Theta Trading Technologies, says these venues only allow EMSs to place so-called staged orders, which must then be executed using the venue’s technology, rather than within the EMS.    

“Even if you are using an EMS it is not able to operate fully because all it’s doing is routing those orders into a venue,” he says. “While those venues may support enhanced order routing/staging and indications of interest, the process is order­ driven. They don’t provide request-for-quote or executable-streaming-price protocols direct to a client’s EMS to support aggregation. All trading functionality is handled on their own proprietary screens.”

Venues are reluctant to disclose anything regarding their API most of the time

Sylvain Thieullent, Horizon Software

As a result, clients cannot initiate an RFQ or click-to-trade an executable price at certain venues from within the EMS.

This may keep fixed-income EMSs out of the scope of rules governing trading venues, for now. However, EMS vendors are pushing venues to improve their APIs and make them more accessible.  

“Fixed income electronic markets should be moving towards the FX markets, where greater technological transparency has allowed institutions to seamlessly interact with venues,” says Quod Financial’s Gabbay.

Some trading venues are moving in this direction. For instance, MarketAxess allows clients to initialize an RFQ directly from an EMS such as TradingScreen via the venue’s API. MTS RFQ platform BondVision also supports auto-execution via RFQ. This is not currently possible on Tradeweb or Bloomberg, sources say. EMS vendors say fixed income still lags other asset classes when it comes to the functionality and openness of APIs. Equity and FX platform make their APIs readily available—or even public in some cases. Fixed income venues tend to closely guard theirs, only making them available if there is an ‘indication of interest’ from an existing member. 

“In equities, vendors can choose to invest their efforts with a target to acquire a customer later, once the connectivity is developed and ready to go live,” says Sylvain Thieullent, chief executive of Horizon Software, another EMS vendor. “In the FICC world, venues are reluctant to disclose anything regarding their API most of the time. Not only is interest needed, but sometimes a legally binding agreement between the member and the vendor must exist for any documentation to be disclosed.”

Thieullent argues this is stifling competition. “That makes the situation very closed to new competitors, as one of the key requisites for members is to choose vendors because they have connectivity with a venue. It’s a chicken and egg situation.”

The initial belief was that by restricting API access, you maximise your liquidity capture, your stickiness. Instead, what’s happened is that those people who opened up their APIs have seen just the reverse, that they have more activity going on

Jay Hinton, Charles River Development

Venues are holding firm, though. Bloomberg says clients can send orders directly to its terminals from their order management systems and automate execution using its Rules Builder tool, which went live last year for fixed income.

Tradeweb also has its own automated execution tool, called AiEX.

While some venues are open to EMSs aggregating their liquidity, they don’t want them to offer competing workflows. Jason Quinn, chief product officer at credit platform Trumid, says that if EMS vendors are trying to get to a point where the clients can have full access to a venue without having to use its screens or tools, “then my ability to innovate is at the mercy of your ability to code to my innovation.”

EMS vendors say this view is shortsighted. Axe’s Mihov says fixed income venues could learn from equities. “I’ve heard feedback from the buy side saying they are likely to direct more flow to venues that offer full trading APIs so they can optimize desktop real estate,” he says. “In equities, if they are trading on 60 exchanges, do they want 60 screens open? Of course not.”

Jay Hinton, director of product management at Charles River Development, an order and execution management system provider, is of a similar view. “In the trading space the initial belief was that by restricting API access, you maximize your liquidity capture, your stickiness. Instead, what’s happened is that those people who opened up their APIs have seen just the reverse, that they have more activity going on,” he says.

But given regulators’ concerns about EMSs in equities and FX, replicating that model in fixed income may not be straightforward.