Reducing the human touch

Buy-side priorities have been historically dominated by regulatory concerns, but a survey of senior FX buy-siders carried out by Worldwide Business Research suggests that automation is now taking over. Hayley McDowell examines the benefits, challenges and progress as asset managers look to reduce the human touch on trading desks.

It’s no secret that inadequate technology will be costly to the buy-side. Now, more than ever, the buy-side is embracing the use of new technologies on trading desks as a matter of urgency, where, in some instances, it is taking priority over human traders.

Research implies that buy-side trading desk budgets are moving in favour of technology at the expense of trader compensation. Greenwich Associates published a report in February which found that budgets for buy-side trading desks have remained relatively flat in recent years, but traders could see a drop in compensation and bonuses as those budgets pivot towards investments in technology.

On average, asset managers spent 70% of budgets on compensation and 30% on technology, but last year the allocation had shifted noticeably to 60% on compensation and 40% on technology.

At the beginning of this year, Worldwide Business Research (WBR) spoke with 100 heads of trading and foreign exchange (FX) buy-siders across Europe to discuss the use of technology on trading desks, ahead of this year’s TradeTech FX Europe conference.

It produced some interesting results, but the most prominent message from the buy-side by far was that automation is quickly taking precedence. A staggering 77% of respondents said that reducing the human touch on FX trading desks is presently their biggest priority. Better pricing and execution, reduced trading costs and improved controls were highlighted by respondents as significant benefits to reducing the human touch and increasing automation on trading desks.

“I agree that reducing human touch on the FX desk should be the top priority here,” Alex Smyth, head of trading at Florin Court Capital, says about the results. “The automation of FX flow will allow for reduced trading costs via investment in scalable technology which can automate human workflow.

“For example, it can allow for faster trading by executing multiple orders simultaneously. It can also result in improved controls via reduction in human error, and allow for greater optimisation by freeing up time spent on ‘button clicking’ to focus on execution review.”

The survey found that just 2% of respondents have automated more than three-quarters of FX trading flow, while a majority of 59% have automated between 26-50%.

For the larger buy-side FX institutions around 80-90% of trading flow is automated in G10 currencies, whereas for mid-sized asset managers, FX has traditionally been seen as a by-product of another asset class with little need for investment in technology. But, as the benefits of automation come to the forefront of the industry, this trend is clearly changing.

“Failing to automate will result in uncompetitive and outdated practices and increased operational risks,” Smyth adds. “As automation proliferates, more time will be spent on review of trading and execution rather than the underlying activity. For example, being able to understand data and draw conclusions from transaction cost analysis (TCA) reports will be very important.”

Shifting structure

Shifts in market structure and regulatory oversight have also had a major impact on the buy-side’s adoption and use of technology. MiFID II, for example, has introduced a raft of new technology-focused obligations and costs for the buy-side to contend with.

“E-trading certainly improves efficiency and reduces the cost per trade, but the key driver of this trend is that buy-side institutions are increasingly being put under the microscope in terms of demonstrating best execution,” says Jon Vollemaere, CEO of electronic marketplace for FX trading, R5FX, who points out that traders are no longer working on a best effort basis and must now use data to justify their decisions.

“This transparency demonstrates just how wide the price variance really is across different customer types. Even though MiFID II does not specifically apply to spot FX, many buy-side institutions are now also using the same processes across all asset classes, meaning that more FX is being done electronically. This enables institutions to demonstrate compliance, with access to tick data and timestamping.”

However, implementing new technology on buy-side trading desks is no mean feat. In fact, despite it being a priority for the majority, 51% of FX buy-siders told WBR that the biggest challenge this year is increasing on-the-desk technology. Multiple, layered legacy systems, costly investment and set-ups, alongside the need to connect to more FX trading venues, can prove to be significant barriers for asset managers aiming to reduce the human touch.

Vollemaere adds that it is important to remember that automation can mean different things to different buy-side institutions, depending on their size, trading styles, market access or resources to invest in such technology.

“To a large buy-side institution [automation] means accessing and consuming ultra-low latency market data, integrating that with their core price engine and distributing to multiple electronic trading venues. For others e-trading may mean simply connecting to a trading platform, to gain three or five prices and trading on one of those.

“Clearly the level of investment is significantly more in the first example. Also, e-trading typically interfaces with multiple other legacy systems. Because of the complexity and interconnectedness of this technology stack it is often the case that making changes requires a sizeable change programme – we know that these programmes often run into years.”

Change is inevitable

FX industry experts and market participants agree that automation in FX is inevitable. WBR’s survey asked the buyside about what they consider to be the most important characteristic of any new FX initiative coming to market, with a majority of 18% highlighting that state-of-the-art technology or functionality is the most significant aspect.

One buy-side respondent commented that in some cases technology and functionality is of far more importance than cost. Market participants generally have the bases covered in terms of FX trading, but will be increasingly looking to new forms of innovation with greater enthusiasm, such as artificial intelligence, machine learning and algorithmic execution.

“Increased electronic trading, and the resulting automation, is inevitable,” says Alina Karpichenko, global marketing manager at infrastructure specialist Avelacom. “All firms need to really look at their IT infrastructure when implementing these processes. While many of the most sophisticated high-frequency trading (HFT) firms and tier one banks are already doing this, newer entrants to this market need to ensure they have the most fit-for-purpose technology and infrastructure to keep up with industry trends.”

Karpichenko adds that buy-side firms are also looking for software and technologies to compete with the HFT firms and tier one banks with increased access to multiple exchanges and low-latency. But implementing an automation strategy is hardly a short-term project, particularly when there are other aspects to also consider.

“For firms not yet actively trading electronically in any meaningful way, an important consideration will be the need to increase their internal skill sets,” she says. “They need highly specific competencies to effectively review, grow and upgrade their technology as part of a process to implement the necessary high-speed IT infrastructure connected to multiple venues.”

The shift in priorities on the buy-side in FX is certainly highlighted in WBR ‘s survey. Long-standing concerns about compliance with new regulatory regimes have loosened and been overtaken by the need to automate certain trading and investment processes.

As with other asset classes the automation of FX will continue apace. Being able to overcome the barriers in reducing the human touch on trading desks, such as potentially huge costs amid failing legacy systems, will prove to be a key differentiator across the buy-side when it comes to FX.