Waking up to FX
I didn't think FX was a serious
source of alpha for institutional investors, so surely it’s at the back of the
queue for IT spend?
most other asset classes, greater investment in FX capabilities is largely being
led by an evolution in trading and execution dynamics, rather than sweeping
you’re right, FX trading has traditionally been an afterthought for most
buy-side traders who typically use it to hedge the currency risk associated
with stock and bond transactions.
meant measuring the execution quality of FX trades has not been front of mind
on institutional trading desks.
was until custodians including State Street and BNY Mellon were alleged to have overcharged asset owners and money managers on their FX trades to the tune of
millions of dollars.
these firms have since committed to providing more transparency on FX trading
fees, while the buy-side begun to take more notice of how its FX trades are
not a priority for the buy-side, FX has been a highly automated market for many
years. In recent times, an increasing number of high-frequency trading (HFT)
firms have looked to profit from arbitrage opportunities. There has also been a
greater adoption of broker-provided execution algorithms by the buy-side. A May
study from consultancy Aite Group estimated that 40% of spot FX volumes now
come from high-frequency strategies, although much of this was thought to come
from banks’ internal desks, rather than pure proprietary trading firms.
How have these trends affected the
tools on offer to the buy-side?
in the wake of the overcharging scandals, the buy-side has upped its use of
transaction cost analysis for currency trades, with TradingScreen, ITG and
Abel/Noser all releasing products in recent months.
and other vendors have also realigned their offerings to better cope with
increasing levels of electronic trading. Last week Deutsche Bank overhauled its
Autobahn FX platform to give the buy-side more control over manual and
electronic executions. Meanwhile, Thomson Reuters recently finalised its
purchase of multibank trading platform FXall, adding new execution options for
the firm’s existing buy-side clients.
of these developments will help the buy-side to be more cost-effective FX
market participants, taking more care to execute currency trades at the most
optimal time, rather than handing them over to custodians or waiting for the
fixed FX rates published at 16.00 everyday, which can carry market risk.
What impact has HFT had on liquidity
in the FX market?
paper from the Bank for International Settlements last year noted that HFT in
the FX market had led to tighter spreads and enhanced liquidity.
“[HFT] firms are efficient in
mobilising liquidity around the system and between different venues, which is
important in a fragmented marketplace,” read the paper.
well as single dealer platforms, multi-dealer platforms including FXall,
Hotspot FX and Currenex also offer FX execution options.
as always, where there is HFT there is controversy. Similar to equities,
continued automation piles downward pressure on the value of trades. The BIS
paper also noted HFT in FX had led to fleeting orders that can give a false
impression of liquidity and be detrimental to those participants that want to
execute quickly and in size.
How have FX market participants
responded to HFT growth?
HFT backlash in FX has already begun. EBS, the FX trading platform operated by
ICAP, recently adjusted its rules to make it less favourable for high-speed
trading strategies that probe the market for indications of liquidity and price
and said it would monitor order-to-trade ratios.
broker Tradition launched TraFXpure at the start of June, which seeks to create
a level playing field among market participants by reducing technological
suggest that the buy-side are changing tact when it comes to FX trading, with
previous arrangements for trading FX shown to be flawed. Market participants are
also seemingly keen to avoid the same HFT debate that has lingered in equities
by taking action to protect the quality of liquidity.
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