FX growth driven by algos, HFT
Asia’s FX markets are following the path taken by equities in the rapid uptake of algorithmic and high-frequency trading, accompanied by similar price and margin competition and battles for technological supremacy, according to Rob Hodgkinson, director, Asia Pacific at Northern Ireland-based software and consulting services firm First Derivatives.
With equities volumes down across the board, the already huge FX markets have been attracting even more institutional flow. In response, Asia’s electronic trading platforms are competing hard to gain market share. Across the region, China, Hong Kong, Japan and Singapore are leading the way in the automation of FX trading, with Australia also witnessing increased activity recently. Japan saw volumes increase by 15% last year, while Hodgkinson describes Singapore as becoming, “something of a hub for FX".
“Brokers are seeing more demand for FX-related services and the whole sector is becoming more competitive,” he says. “While equities adopted algos and highly-automated trading first, we’re now seeing a big catch-up in FX. And FX markets have been aggregating multiple market sources for years, so in some ways are ahead of equities.”
Challenges remain. The lack of central exchanges for FX creates an environment of “more natural competition”, suggests Hodgkinson, who believes that the major players that now control much of the market will be reluctant to give up the margins they earn to any centralised marketplace. And although the sector is clearly growing, FX is still mainly used by most traditional buy-side firms to hedge their currency risk or make portfolio adjustments – so the demand from these firms for highly advanced algo and HFT strategies is still limited at present.
“The asset managers remain the clients of the banks and FX brokers,” he says. “They typically want more competitive spreads and margins, but any electronic interest is primarily to expedite the hedge orders via DMA through their FX broker or bank. There is some interest in running strategies, but not actively, for example to send hedge adjustment orders in a batch through the broker or bank. This is not an low-latency type activity, but just a daily position adjustment.”
Nevertheless, market participants in FX have some of the same concerns as those for equities, including ’rogue’ algorithms, fragmentation and the pressures of being part of an increasingly complex and competitive environment. As a result of the rapidly changing marketplace, traders are dealing with more specialised and complex requests from clients.
Firms looking at algorithmic strategies for the first time need to consider four main aspects – a technology platform; historical and ongoing data; risk management and transaction cost analysis (TCA), according to Hodgkinson.
Tech platforms need to be high performance with full Level 2 market depth capabilities, he suggests – allowing participants to see data for the highest and lowest bid and ask for each individual market, as well as displaying the volumes on offer. Equally, requirements for data analysis are also increasing, to ensure strategies are working effectively. That is leading market participants to look for comprehensive data analysis going back months and years, he says, although back testing is still being developed.
With the size of many FX transactions being so large, counterparty risk is a major consideration, along with exposure risk to currency markets that have seen periods of increasing volatility over the last few years. Hodgkinson describes TCA as “a key requirement”, particularly with the banks, which increasingly want comprehensive feedback on their trading costs.
While FX has yet to attract the kind of scrutiny that high-frequency trading (HFT) and algos have brought to equities trading, regulators are studying the HFT impact on the market, with participants in Japan already having to make close-of-day position reports.
“The regional potential for FX is still huge,” says Hodgkinson. “And those that aren’t competitive are simply going to lose out.”