By Tim Healy, Global Marketing and Communications Manager, FIX Trading Community.
January is an odd month. A time to look back on the past year, to look forward to the New Year, make resolutions and be very abstemious. All of this following the hectic overindulgence and festivities of the previous month. An odd month indeed.
As we look back over the achievements and milestones for the FIX Trading Community in 2014, we also look forward. There was a huge amount of work done by the various committees, subcommittees and working groups during the year. The events organised by the membership and the FIX Program Office were very well received. The targets and aims for 2015 are to continue this work and improve on what we did during 2014. The markets move and we need to keep up to speed with them.
Looking back first, there were a number of specific highlights for the year across the different regions.
The Asia Pacific Regional Committee worked collaboratively with a number of different bodies such as the Singapore Exchange (SGX), Hong Kong’s Securities and Futures Commission (SFC) and the Hong Kong Shanghai Stock Connect Project to further promote the use of FIX. Additionally, the Committee established a group to promote ‘new blood’ into the region and encourage greater participation.
In October, the Japan Regional Committee helped to host the Biennial Japan Trading Conference which saw a record number of delegates – more than 600 people attended the event. The President and CEO of the Tokyo Stock Exchange, Akira Kiyota, gave a keynote speech and outlined their plans to become the premier exchange in Asia. The Committee also worked closely with the Financial Information Services Centre (FISC) in Japan to provide information for its annual report.
In EMEA, the work of the Investment Management Working Group was to the fore with continued development of the execution venue analysis and a new initiative to address the workflow for transmission of orders for Initial Public Offerings (IPOs). The Trade awarded the IPO initiative the Buy-side Project of the Year. Our flagship EMEA 2014 Conference was a great success and planning is in full swing for the 2015 event on 10th March.
In the Americas, similar to what has been done in EMEA and Asia Pacific, there was a drive to get fresh impetus in the region as two new networking groups were launched in New York and Boston. A successful conference in Brazil was followed by a standing-room-only audience in New York to discuss Trading and Transparency. Elsewhere the region also re-launched the Risk Management Working Group to look at a number of different topics as well as globalize the group.
Looking at the more specific product Committees, the OTC Markets Committee Group accomplished a large body of work as the Fixed Income and Foreign Exchange markets become more electronic and regulated. The vast majority of Swap Execution Facilities (SEFs) and bond trading venues use FIX and the Committee continues to engage with both venues and vendors to push for greater standardisation. Project Neptune gained a lot of media attention during 2014 and our penultimate press release of the year announced the draft publication of the Best Practices for the use of FIX for pre-trade in the bond market.
The Global Buy-side Committee was active across all regions during 2014. Inherent differences in every country and region means that there are diverse challenges to be met but the global collaboration on the IPO Initiative and the Execution Venue Initiative show that working under the umbrella of the FIX Trading Community, significant results can be had. Additionally, the Global Post Trade Working Group are working to widen the asset class coverage for FIX in the post trade space having published guidelines for equities earlier in 2014. There will be a strong focus on regulation in 2015.
The Global Technical Committee has focused its efforts on High Performance whilst also continuing to develop FIX to address the significant increase in regulatory activity. Their work on the next generation of the FIX Protocol will fully support high performance on all levels (application, presentation, session) with the objective to offer an open standard that can replace today’s proprietary interfaces for high performance trading and market data.
Each committee has outlined its own respective targets for 2015, however there are a number of themes that cut across all the different working groups and committees:
• Continue to assess the ongoing changes in regulation and address how FIX can help.
• Continue to work with different trade associations and regulatory bodies to promote the use of standards in the different markets.
• The promotion of FIX as the de-facto messaging language for all asset classes.
• Continue to encourage greater involvement from market participants.
• Continue to encourage new users to become involved with the committees and working groups.
One other area which FIX will look at is cybersecurity and if there is a role that the FIX Trading Community and its members can play to address the issues in this space. This will be a new departure for the Community but given the prevalence of FIX in the lifecycle of a trade, the information that can be gleaned could prove to be key in helping meet the challenges.
The work that these groups do should not be underestimated. The FIX Trading Community holds a somewhat unique position in the market and will continue to work in a collaborative and unbiased manner as we go through 2015.
Let’s hope it’s a good one.
Another Year Over And A New One Just Begun…
Processing FX Algos
With Damian Bierman, Head of Asia-Pacific Operations, Portware
Portware has the ability to implement a straight through processing layer that reads proprietary signals from a customer’s OMS and creates recommendations to traders or follows signals systematically through execution. The system constantly evolves and learns based on each trading experience and trader interaction. Campbell needed a trading platform that would integrate seamlessly with its proprietary order management system and give traders one platform to execute orders against any bank, ECN or interdealer offering. We also have the ability to provide comprehensive pre- and post-trade transaction cost analysis (TCA) and quickly identify liquidity trends.
The algorithm characteristics are varied from ultra-passive to ultra-aggressive and can combine internal customer research data and Portware analytical components enabling them to trade with a number of different strategies on both streaming liquidity and posted venues.
As the FX market continues to become increasingly electronic, firms are beginning to recognise how FX algos and integrating this element of trading with a more holistic set of TCA can be a competitive advantage. Both the buy-side and sell-side need to keep pace with new industry standards, and automating critical trading systems and the relevant data capture is a key part of this.
Adding on FX in most cases is as simple as adding the appropriate liquidity providers and deploying the FX specific look and feel components. The entire system is built to easily add on features where and when needed quickly and painlessly.
The way Campbell trades is somewhat unique. Their client base is global and full of complexity. Portware built features in the system to help create synthetic term trading solutions while also keeping in mind the need to book trades at a base currency and supply the appropriate information to their OMS and internal repositories.
Retailing Research: From Big-Box to Farmer’s Market?
Asia Independent Research Providers’s (AIRP) Ed Stockreisser and Shan Han discuss the market for research, their new solution SeedAlpha, and predict how regulatory and economic pressure will reshape buy-side consumption.
As institutional investors and the bulge bracket brokers who service them discuss the ramifications of potential unbundling rules in the UK, independent research providers see an opportunity to gain market share providing a diverse, specialised analysis.
There have been four key developments in research provision over the last five years: the decline in commissions; the decline in payment for research; an arguable decline in the quality of the sell-side research; and a decline in the hard dollars used to pay for research, handle/corporate access and related services. Quality analysts are more likely to leave the sell-side for the buy-side or to become independent as sell-side firms downsize senior analysts positions.
A central theme in the regulatory discussions is the inherent conflict of interests in bundled models and subsidised research models, which has begun to sway buy-side opinion. Lack of cost transparency and reduced service quality explain the current pressure on research models, including those from the FCA.
Many of the managers we speak to are wholly unprepared to assign a value to research. The buy-side focus is largely on how they use research in their investment activities, effectively ignoring the research that is being discarded. The Boston Consulting Group estimates that as little as 10% of research is read. A ban on using client commissions to pay for research and corporate access entirely from 2017 opens up a new paradigm for the consumption and creation of research.
With the fragmentation of the research market, the cost to get research in front of the right consumers, or the cost for the fund managers to go out and access this research, is increasing. This is an opportunity for technology to shorten that gap and make it more efficient. Our aim is to increase the value of research from the way that it’s used across the team. The problem the buy-side has is with assigning value to research, but the more people that use one piece of research, the more you can actually justify a higher valuation. Once a firm has established some sort of budget or spend on research, it will change the way that they consume research.
Creating a research price index provides an indicator as to what a piece is roughly trading at in the market, bearing in mind that research has no value until it is read and that it has a different value for each reader. Compliance audit trails are also built in to track research budgets from the CIO down to individual analysts and teams.
One of the biggest buy-side pain points is that there is so much research on offer that even if they take research from five bundled brokers, they still receive 400 emails a day: something like an unlimited buffet of junk food. All the buy-side really wants is: A) a way to find the best research from existing and best-in-class providers and B) to manage that in one platform without having to go through broker portals, search emails, use Bloomberg and a range of external different sources.
In an effort to reflect a higher value of research consumption, we are charging the buy-side to join the platform instead of the research providers because ultimately what we care about is investors having access to better research. This may mean sell-side research, but as fragmentation occurs, investors want the best research on behalf of clients and we leave it to the regulators to determine how that is paid for.
Long-term
A more diverse research ecosystem is a hoped-for outcome, as many independent research providers (IRPs) do not have sales teams as is true for some regional brokers. If their research can be purchased side-by-side with larger firms’ research, it can potentially create a competitive advantage within their niche.
Despite bundled financing, large research providers face cost pressures, which will likely discourage exhaustive coverage in favour of specialised focus on core competitive advantages. With the exception of the biggest brokers, who will continue to fund quality research in all areas despite unbundling, the majority of research providers will likely become specialists. These disparate providers will need a glue to bind them together – a table for everyone to sit at.
More than ever before, there must be a justification to spend client commissions on research, yet rarely does one piece of research lead to an investment decision. Over the course of reading possibly hundreds of pieces analysts eventually form an investment idea. Manually tracking that process is virtually impossible, but we can technically automate much of the tracking to justify how the idea develops.
At present, there is pressure on fund managers from the regulators, clients and economic forces. In turn, the sell-side will be pressured into changing. Eventually, perhaps in 10 years’ time, investors will look back at how research was being done now and be grateful it is not done that way anymore.
Plugging Social Media Into Financial Services
By Oli Freeling-Wilkinson, CEO, Knowsis.
There is a whole world of conversation that is occurring in social media and online that people in finance are not effectively plugging into. It is starting to become a problem because social media is increasingly relevant to financial services, especially with regards to how regulators now view social media, and are accepting it as a distribution point of data. More and more types of people are disseminating information through social networking, and it is becoming an increasingly important part of the jigsaw – not answering questions in and of themselves, but as a tool for monitoring information, and for depth and breadth of knowledge.
A lot of organisations have no social media strategy or engagement to extract value from new technologies. There are examples like Carl Icahn who use it very carefully and well, but they’re only the tip of an iceberg – financial services and trading need to think about how they use the data, and what else is out there that they should be thinking about in the future – sources of data that haven’t been factored in and that haven’t been taken advantage of by other firms.
A change is in the air when it comes to social media because of its increasing relevance – if you’re in a trading department that covers a given sector, the fact that companies can disclose information through social media networks makes them vital channels of information – the regulator has opened the door and firms will charge through it, and traders and PMs have to follow that information flow.
People haven’t been able to effectively deliver a solution that takes the wider social media universe and makes it applicable, and compliance ready, for investment banks and asset managers – there is a balance and a challenge but solutions are out there.
There are plenty of challenges in the market right now, but there is always a greater need for information, inspiration and analysis, and those wider sources of information can be found in social media.
End of era x 2 : Lynn Strongin Dodds
End of an era
End of an eraThe year has barely begun and we are already witnessing the end of an era – the closure of CME’s futures trading pits in Chicago and New York that date back to the 19th century. The handwriting was on the wall for a long time as electronic trading eroded the open outcry mode of dealing which now only accounts for a mere 1% of the CME’s volume.
Of course it is in the name of progress but it has been a time of nostalgia. The positive is that electronic trading opened the markets to global interaction and hence reduced trading costs. The negative is that this interconnectedness increased volatility and as a result when market events such as Greece or Ukraine erupt it reverberates around the world. There is also the human element. The pits may have resembled rush hour at Grand Central Station, with yelling and pushing, but there was time, albeit short, for reflection instead of today when decisions have to be made in a split second and hopefully the right keys are being pressed.
Europe is also looking at the end of a different kind of chapter – the separation of execution and research and again it has been well signalled. In fact, UK introduced unbundling over a decade ago, with fund managers paying for research via commission-sharing arrangements (CSA). However, the Financial Conduct Authority believes they have been ineffective and that investors are still paying over the top for research.
The MiFID proposals are expected to have more teeth and are requiring fund managers to pay for research out of their own funds via a separate account. This must be funded in advance, operate within a budget set by the manager and not be linked to the volume of transactions executed. Although many were relieved that the proposals did not impose an outright ban, they are more onerous than expected and there is a great deal of lobbying going on behind the scenes.
While it is too early to predict the outcome, it will not mean the end of broker research, although if the UK experience is anything to go by, it is those at the smaller end of the spectrum will suffer. Numbers crunched by the CFA Institute showed secondary commissions to UK small and mid-cap brokers dropped by an estimated 80% since 2007. The global and larger players are better placed to weather the storm although it will be a seismic shift as revenue generation and market share among European equity brokers are largely determined by the breadth and depth of their research arms.
Lynn Strongin Dodds,
Managing Editor
©BestExecution 2015
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Technology On The Thailand Exchange
With Kesara Manchusree, President of the Stock Exchange of Thailand.
Bringing markets together onto one platform
The Stock Exchange of Thailand recently changed our trading platform for the equities and derivatives markets. We changed equities two years ago, and we brought derivatives onto the same platform this year. This is a reflection of the cash equity market size and our desire to unite across our platforms. We were using an in-house platform, but we decided to buy the new system because we believe that technology has become more developed and we need to be at the forefront of that. The new system, called SET CONNECT, supports a higher throughput and has lower latency together with greater functionality to support new products and new connectivity. It also includes another API set that we are going to offer to clients.
We have been working closely with our market participants during this period of change and their reaction has been positive. We have about 40 market participants and we have been working with them for almost two years around this implementation. Market participants in Thailand mostly use the local ISP but after we introduced the new system, we found out that they are increasingly using international ISPs to come into Thailand. So thanks to the new platform we are seeing new names enter Thailand and their feedback has been very good.
Around the region many other markets have been very busy, because a lot of exchanges have been changing their trading platforms. We have been working very closely with both the local and the regional brokerage houses to keep track of their technology updates and to ensure that we are aligned with their needs and the changes happening region-wide.
The effects of Shanghai-Hong Kong Connect
We have been listening to the plans for the Connect between Shanghai and Hong Kong with interest and I have personally visited both Shanghai and Hong Kong recently. There are clear benefits for both exchanges, but I think the real positive consequences will be for brokers in Hong Kong to access the Chinese market very easily. In term of the effect on the Thai market and other regional exchanges: I think that they are at the beginning of a long journey. While we will keep watching what happens with interest, there is little real interest from the Thai market to invest in the Chinese market. There are however definite opportunities to extend our market into China and for China to extend their investment into Thailand.
The Thai market has been doing a lot of marketing to Chinese investors, with returns this year so far on the index of 21%. Listed companies in Thailand are very attractive in terms of our returns.
Regional co-operation
Each regional market uses different systems and has different characteristics. In term of the connectivity, in terms of technology, everyone has their own API that can connect to each other. As long as we can connect to each other, trading will happen and there is every possibility to build on this connectivity. But there are many complications when you have to take into account the different rules and regulatory jurisdictions throughout the region. We are looking to develop our relationships between the Thai market and other regional markets along the lines of the ASEAN link we currently have between Malaysia, Singapore and Thailand.
This cooperation will keep growing because every exchange is working on expanding their market. For example, the Thai market is working with Deutsche Bourse on the cross trading of derivative products.
What we do need to ensure is that we have proper monitoring technology to manage these growing markets. We just bought a new surveillance system, called SET WATCH and now we have our own in-house surveillance. This also means that we are working on defining all our data to standardise. Our regulator is also involved and has their own monitoring system, so there are definitely developments in this area throughout Thailand and more to come.
Emerging Markets – Risks And Opportunities
By Rohini Tendulkar, Economist, IOSCO
Over
the last decade, emerging markets (EMs) have, on average, grown almost as fast twice as advanced economies (AEs). Recently, accommodative monetary policies and low interest rates in the developed world have triggered a search for yield, encouraging investors to the door of EMs, where expected returns are generally higher. Furthermore, Chinese demand has fuelled ‘south-south’ lending and supported growth across the EM regions. These developments mean economic and financial activity is less concentrated in AEs, providing new global investment opportunities elsewhere.
However the ‘taper tantrums’ of mid-2013 and beginning-2014 and the impact of this on capital flows to EMs, raises the spectre of ‘boom-bust’ cycles and reveals the heterogeneity of these markets in terms of economic, financial and institutional conditions – and their varied ability to withstand shock.
The IOSCO Securities Markets Risk Outlook 2014-15 (The Outlook) explores these developments and the potential risks from a securities markets perspective. It points out that in recent years the proportion of cross-border flows of non-bank credit has increased, rendering a more diverse global financial ecosystem. More conservative bank lending practices in developed markets caused by regulation such as Basel III may be responsible, in part, for this shift, though it could also be a symbol of financial and economic maturity.
However, while securities markets in EMs are generally increasing in size, they remain relatively illiquid compared to AEs and in some cases heavily reliant on cross-border flows. In this context, two factors to take into account when considering risk include: (1) shifts in global economic conditions; and (2) technological integration.
(1) Shifts in global economic conditions
The continuing unwinding of monetary stimulus in AEs, particularly the US, in combination with lower Chinese growth rates, increased perception of political risk in some countries, and more recently, falling commodity prices, has implications across EMs. A reversal of capital flows could impact exchange and interest rates, resulting in significant asset price devaluation. Currency depreciation could translate into inflationary pressures and complicate the servicing of debt.
While some EMs weathered the turmoil of the ‘taper tantrums’ relatively unscathed, others – such as Brazil, South Africa, Indonesia, India and Turkey – felt impact on their currencies, interest rates and slack in their equities and bonds markets.
Recent quantitative easing by the Japanese Central Bank, and hints of the same from the European Central Bank, has continued market expectations of liquidity. However the subsequent devaluation of the Yen, especially against the South Korean Yuan and the Chinese Renminbi, has implications for China’s slowing growth, from 10.4% in 2010 to 7.4% in 20141, and South Korea’s export competitiveness. By extension cross-border flows to EMs in Latin America, Asia, Europe and Africa that rely on trade with and lending from these two large economies, are vulnerable to volatility.
Falling commodity prices, in part spurred by China’s slowing growth and also idiosyncratic factors such as political risk in the Middle East and Russia, impact flows to export-dependent EMs.
Particularly vulnerable to these developments are EMs with high current account deficits, low total reserves as a percentage of external debt and steep credit build up. For example, in Brazil the current account deficit increased to -3.5% of GDP compared to -2.2% of GDP in 20102. Total reserves as a percentage of external debt fell to around 48% in 2014, compared with 62% in 20103. Domestic credit to the private sector as a percentage of GDP grew 30% between 2010 and 2013, reaching 70.7% of GDP in 20134. Meanwhile, in the last two years, Brazil has experienced currency depreciation and increased official interest rates. In 2014, GDP growth fell back to just 0.3% compared to 7.5% in 20105. The inflation rate grew to 6.3% in 2014 (compared to 5.0% in 2010).
At the same time, ‘boom-bust’ cycles are not alien to EMs. A string of crises, triggered by volatile capital flows (the Tequila crisis 1994-1995, the Asian crisis 1997 and Russia- Brazil in 1998, etc) have led a number of EMs to introduce macro prudential policies and capital controls aimed at stemming the effects of a sudden reversal of flows. Nevertheless, given the increasing importance of securities markets as a financing channel, the Outlook points to the importance of building robust domestic and international securities markets in EMs – through a focus on nurturing market development, mitigating risks (both systemic and firm level), setting up market structures to improve efficiency and access, and integrating technology.
(2) Integration of technology
The integration of technology into emerging and frontier economies (EFEs) is a particularly salient topic. Technology is changing the financial landscape in unprecedented ways with implications for the way we access, use, finance and invest our money and assets. Processes and transactions are faster, smarter and more automated. Technology is also a facilitator of global integration and financial access. In Kenya, M-PESA, an advanced mobile money system is used by more than two-thirds of the population6, even while local financial markets remain underdeveloped. But while technology offers a host of new opportunities for development and expansion for EFE financial markets – it also introduces new risks. One of these risks is cyber-crime.
In an IOSCO/WFE staff working paper7, it was revealed that around half of the world’s exchanges had suffered a cyber-attack. Cyber-crime can not only choke, disrupt and manipulate financial services and processes but also undermine confidence in the financial system of a jurisdiction, making it a potential systemic risk. Since cyber-space is not limited by national borders, cyber-crime is a truly global risk – one that can affect developed and emerging markets alike. Thus this is a risk that requires both local and global mitigation efforts.
Mitigation efforts include not only prevention and detection/monitoring of cyber-threats but also robust recovery and communication protocols in the case of a large cyber-attack. Furthermore, cyber-crime is not something that can be dealt with by financial firms in isolation. Information sharing mechanisms can assist individual financial actors and regulators in building a clearer and broader picture of the cyber-crime landscape, identifying current cyber-threats and anticipating future cyber techniques so that resources can be allocated efficiently.
2 IMF estimates
3 IIF forecast, Reserves excl. gold.
4 World Bank data
5 IMF estimates
6 “Why does Kenya lead the world in mobile money?”, The Economist, May 27th 2013
7 Rohini Tendulkar, “Cyber-crime, Securities Markets and Systemic Risk”, IOSCO Staff Working paper, July 2013
Unforeseen Consequences
Rudolf Siebel, Managing Director of German Investment Funds Association BVI questions whether the FCAs recent CSA proposals will improve or harm continental asset managers’ service.
The Financial Conduct Authority’s (FCA) recent announcements about Commission Sharing Agreements (CSAs) affect asset managers on the continent just as much as their UK counterparts, according to German asset management association, BVI’s Rudolf Siebel.
Continental asset managers were surprised that the ESMA is addressing the subject of unbundling. Given that the Level 1 directive does not discuss research, but speaks in general terms about inducements, we were surprised by the direction the ESMA took. Our members are now investigating what is driving the FCA in this discussion.
We previously introduced a Code of Conduct which also covers soft commissions and research stating research must be used for the benefit of the client, e.g. the investment fund. However, the recent focus on unbundling urged us to send a letter to the FCA. It is not our policy to comment on a purely UK consultation, but because of its wider European reach and its possible impact on the discussion at ESMA level, we sent a letter.
The FCA is correct to improve the pricing of research, but better pricing can be developed in different ways. One way which has not been tried before is to set a dedicated budget for research to make this budget transparent. That would have the effect of formally adding pricing to research, requiring asset managers to scrutinize the implicit cost of research in the execution of fees. If asset managers disclose their research budgets, this would facilitate client scrutiny of that spend.
Beyond research pricing, the FCA identified certain problems such as the overconsumption of research but does not provide any evidence in this regard. The FCA also suggests the quality of research and trade execution is lower than expected. We believe that these alleged inefficiencies should be dealt with by regulation and in any case do not require the action proposed by the FCA. General pricing of research would help mitigate any inefficiencies.
Moreover, we strongly disagree with the claim asset managers are incentivized to trade excessively in order to receive more research, as it is described in Point 5-26. The claim that asset managers disregard the existing obligation to act in the client’s best interest is incorrect. Again, this allegation lacks any evidence. Further it contradicts the FCA’s claims that there is overconsumption and lack of quality of research. It is unlikely that asset managers would create an order to procure research if that research lacks quality. In that case, asset managers would just as soon order and pay separately for specific, recognized, high-quality research.
If the FCA’s proposals are implemented, there may be a number of negative consequences, as other industry bodies and buy-side firms have explained. The first is reduced research and decreased competition between research providers. The proposed rules would place asset managers under pressure to reduce their demand for research in order to balance costs. A reduced market for research would negatively affect competition between research providers, favouring market participants with larger trading books, who can cross-subsidise research.
It is unclear how independent research providers would benefit from such a situation. On the sell-side, smaller, independent researcher firms are likely to suffer, as would smaller asset managers that would find it financially difficult to build their own research departments.
There is a separate concern that small and medium-sized enterprises will receive less market coverage. Already, large research providers essentially focus more on large and medium caps instead of small and medium-sized caps because these entities are more important for trading. Many companies in the DAX 100, for example, could see reduced coverage, which obviously constrains their access to capital contrary to the intention of European and German politicians to provide more long-term financing for these entities. Finally, less exhaustive research inhibits the market’s effectiveness in pricing stocks and other securities.
If the FCA goes forward as proposed, it would exceed any ESMA rules. We hope that the FCA is not considering unilaterally requiring UK unbundling, but we recognise that they are promoting this option at European level. If these rules are tightened both in Europe and in the UK, the asset managers providing active portfolio management would have to re-price their services. This may nudge the market toward non-European managers both in North America as well as in Asia to offer their services cheaper and thereby gain a competitive advantage over European-based managers. We see no plans in the US, Hong Kong, Singapore or Australia to unbundle research and execution.
The potential competitive situation for European asset managers vis-a-vis their international counterparts is not just a theoretical exercise. Major non-European firms, such as Capital Group, Wellington Management, Fidelity and Pimco, are very active in Germany. For local managers, the competition is often on a basis point by basis point level, and if research would become more expensive, that could sway some of the mandates as a lot of German investors are very cost sensitive.
FX And Equities Algos
With David Mechner, CEO, Pragma
What are the fundamental similarities and differences between equity and FX algos?
Both equities and FX are continuous two-sided quote-driven markets, which creates fundamental similarities. Equity and FX algos therefore offer many of the same fundamental benefits. For example, algos reduce market impact by breaking a larger order up into several smaller pieces so that a smaller price concession has to be paid, and thus better execution. In addition, algos can trade passively in a systematic way, making prices in addition to taking, and thus further saving part of the bid-ask spread even for those smaller individual orders. And in both asset classes, one of the major practical challenges of algorithmic trading is managing adverse selection through intelligent routing and order placement policies.
The biggest difference between equities and FX for algorithms is probably the nature of the fragmentation – including the existence of Reg NMS in equities – and the bilateral structure of the FX market – the fact that more than half the spot volume is transacted on a private, disclosed basis. From a trading perspective, this bilateral model provides a lot of flexibility and is in many ways superior to the equity markets. When a dealer knows his client, he’s able to price liquidity more efficiently. In contrast, when dealers have to price orders to be profitable in public markets, they have to price for the worst case scenario. Effectively, in FX directional traders can get better prices by excluding short-term informed traders like HFTs from the equation and transacting directly with dealers.
To what extent is responsibility for FX trading shifting to the buyside?
The basic structure of the FX market is that the buyside trades against their dealers’ P&L. This creates a clear conflict of interest when the dealer is in control of the client’s order – every dollar the client saves is a dollar the dealer loses. This conflict has been starkly illustrated over the past few years by a series of scandals, and is very much on the buyside’s mind.
As a result, the buyside is shifting where trading decisions are made, pulling back control from the dealer. In the context of click-trading, this can be accomplished through aggregation, which is increasingly common workflow. In algorithmic trading, one way to accomplish it is a service bureau model, in which dealers are used as trading counterparties and liquidity providers, not as agents entrusted to control the client’s entire execution.
That said, there will continue to be long-term sustainable and mutually beneficial relationships between dealers and their clients, and indeed this is one of the strengths of the FX market structure. The buyside can achieve this when have the ability to aggregate liquidity across dealers in order to create a competitive environment that eliminates conflicts and keeps everyone honest.
What are the future trends in this area?
Algorithmic trading is still a relatively small fraction of overall FX trading, and it is likely to continue to increase over the coming years for the same basic reasons it has become the dominant way of trading in equities – it adds significant value.
Other than that, short of a regulatory earthquake, the fundamentals of trading don’t look likely to change much. Volatility and spreads will change over time, but there is a natural homeostasis in the markets. Regardless of the market conditions, there is always a spread that is sustainable and provides mutual value for dealers and their customers. Some players may drop out, but as competition decreases and liquidity dries up, spreads will widen, participation will again become more profitable, and new players will step in to keep the markets healthy and efficient.
Announcement : SmartStream
New York, February 4, 2015.
SmartStream Technologies, the Financial Transaction Lifecycle Management (TLM®) solutions provider, today announced that SmartStream has acquired assets related to software, sales and support of IBM’s (NYSE: IBM) Algorithmics collateral solution. This is a strategic deal to enhance SmartStream’s existing suite of solutions, which enables financial organizations to automate the end-to-end post trade lifecycle, decreasing costs and risk.
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