Spoils to the Swift

Riding the derivatives wave

Since its founding in 1973, the Society for Worldwide Interbank Financial Telecommunication has served primarily as a technological conduit for electronic payments between banks. For the past decade or so, the organization has sought to change that, by trying to persuade Wall Street to use the Swift network for the communications required to clear securities trades. The payoff for Swift’s 7,800 financial institution members around the world would be lower per-message fees because Swift can use the same network infrastructure to handle both bank payments and trading activity and spread costs accordingly.

The Brussels-based utility is finally making some headway, thanks to the recent explosion in derivatives trading. Five years ago Swift developed message standards that firms could use for processing interest rate and credit default swap trades. Then in July 2005 the organization hired James Donovan, formerly the COO of Citigroup’s global clearing unit, as its securities industry chief. Donovan has been touting Swift’s potential to Wall Street as regulators have become concerned about processing backlogs in the derivatives markets. A group of trading firms last year, at the urging of the Federal Reserve Bank of New York, issued a report calling for greater automation to reduce a worrisome glut of unconfirmed transactions in the $26 trillion credit derivatives market, for instance.

“These deals are contract-based, but there is no central repository and no capacity for buyers or sellers to see exactly what they are dealing with,” says Donovan.

As a result, communications between market participants are often ad hoc and heavily paper-based. Swift provides standard electronic message protocols for the most commonly used back-office communications, making the process more efficient.

The group’s efforts are paying off. Through July securities messages accounted for about 37 percent of Swift’s overall traffic this year, up from 34 percent during the same period in 2005, according to Simon Cleary, the utility’s London-based head of securities markets.

Swift is also in the process of improving its message standards for derivatives transactions, so that by year-end they will encompass the full range of possible communications required by Wall Street firms. The organization is working with a group of 15 of the world’s biggest derivatives dealers that have committed to use its new, Internet-protocol-based network — dubbed Swiftnet — to clear trades. These firms can use either Swift’s message standards, which have been certified by the International Standards Organization, or the FpML protocol developed by the International Swaps and Derivatives Association. (Securities firms can also use networks operated by private vendors, such as BT Radianz, to communicate using these message standards.)

Swift has had a reputation for being ponderous and bureaucratic, but its efforts to attract business from Wall Street have required it to be nimble and responsive. “This demonstrates that Swift can be much more pro-active to the needs of the market,” says Donovan.

The utility’s ambitions don’t end with attracting more trade-processing traffic from Wall Street. Swift also longs to get a piece of the market for front-office communications — those pertaining to price quotations and other pretrade activities. But those hopes suffered a blow last year when the industry group that owns and maintains FIX, the financial information exchange protocol for real-time securities messaging, ended a memorandum of understanding it had established with Swift to work on the convergence of their standards. The FIX group judged that its standards were gaining enough acceptance for posttrade communications that it no longer needed to ally with Swift.

Some industry watchers believe that the FIX group holds a natural competitive advantage because it was formed to develop message technology for trading, for which speed to market is critical. Swift, on the other hand, has typically taken much longer to develop standards because it has sought consensus from its banking industry members. That may inhibit Swift from supplanting FIX in front-office communications. But FIX also faces an uphill climb to claim back-office business from Swift, whose members have invested in the utility’s technology over the years and thus have an incentive to continue using it.

“Swift lives in the back-office settlement processes,” says Peter Delano, a senior analyst at research firm Tower Group. “This split is likely to continue for some time. I can’t see FIX messaging moving into settlement and displacing Swift.”