Execution algorithms unlikely to be ‘magic bullet’ for FICC

Report from FMSB emphasises limitations and challenges in adopting algorithmic trading in less liquid markets.  

Execution algorithms are no ‘magic bullet’ in fixed income, currencies and commodities (FICC) trading as they are in cash equities, as challenges persist in adoption in less liquid markets, a new report has highlighted.

According to the FICC Markets Standard Board (FSMB), the use of execution algorithms offered by banks or dealers to clients on an agency basis for order execution remains lower in FICC, with fundamental issues around data and governance persisting.

Execution algorithms are typically implemented by the buy-side to reduce execution costs and market impact, as well as assisting in best execution efforts. While they have been used in cash equities far longer for those reasons, it’s improbable that execution algorithms will deliver the same benefits in FICC.  

“Execution algorithms should become very useful tools for driving efficiency in FICC market structure and to alleviate some of the cost pressures that the FICC industry faces, but they are unlikely to be a ‘magic bullet’ in the delivery and measurement of best execution,” the report from FMSB said.

Two fundamental issues that market participants should consider when rolling out execution algorithms in FICC were highlighted by FMSB, including potential conflicts of interest from providers. Banks largely trade in an agency role for cash equities, but they are more likely to act as principals with significant inventory in FICC, meaning clients could face competing interests of the bank or dealer provider.

Another issue is the lack of availability of data inputs in less liquid markets, compared to equities which dominates primary venues with continuous market data from various sources. For some fixed income products there is no primary venue, and some currencies may represent a small portion of the overall market, presenting considerable challenges in sourcing accurate market data.

According to the long-only results of The TRADE’s Algorithmic Trading Survey 2020, larger asset managers are likely to use several algo providers to manage multi-asset class portfolios. Beyond algorithms in equities, new regulations such as the uncleared margin rules, are fostering greater electronic trading in foreign exchange derivatives, and therefore the development of new algo trading solutions for that market.