Rise of the futures machines

As best execution requirements continue to pressure the buy-side, many are turning to algorithmic strategies in the futures market.

The adoption of algorithmic trading strategies by a variety of buy-side firms in the futures market is increasing, and banks are seeing new competition in this space to serve this growing usage.

“We have seen a rise in the types of clients using algos on futures including CTA’s (commodity trading advisor), asset managers and pension funds,” says Frank D’ Erasmo, head of algorithmic trading, global futures and North America cash equities, Societe Generale Prime Services.

“One reason for this is the drying up of liquidity in the order book, and this has lent itself to more efficient execution and new types of algorithms that can focus on reducing transaction costs and balance market impact risk.”

As a result of electronic execution in becoming widely accepted over time, there has been an evolution as to how algorithmic strategies are developed and then deployed in the listed futures market.

“The markets have become electronified over the last 15 years as technology has become more sophisticated. That has helped the pickup of algorithmic trading and you will see more of that,” says Carl Gilmore, president at Integritas Financial Consulting and former CEO of KCG Futures.

“Algorithmic trading is not going away, the machines are going to get faster and smarter with less and less human intervention, and there is no way things will go back the way they did before.”

In addition, with regulation having an increasing effect on how people trade, market participants see algorithmic trading with their futures portfolio as a means to achieve efficiency and better pricing.

Buy-side firms are now more accountable to their investors as a result of the best execution requirements, and as a result, are expected to adopt methods to achieve efficient pricing and enhanced risk management.

 “Over time, more sophisticated users, particularly those with a quantitative approach, but also those familiar with the equity space have seen algos more in terms of an ability to achieve a better price than by crossing the spread,” says Richard Bevan, global head of electronic trading for exchange traded derivatives, UBS.

“We now see regulation coming into play. In particular, best execution prompts firms to consider how to achieve the best outcome for their clients. Algos play an important and measurable part in this.”

Most banks are providing access to algorithmic models as part of their execution toolkit. However, they are facing enhanced competition in the space from high frequency trading firms, such as Virtu and Citadel, which possess their own unique algorithms.

The high frequency trading firms are able to operate on the same level of the banks, without the high capital charges that the latter faces.

“As algos have been taken up so competition has increased,” says UBS’ Bevan.

This has led to banks re-evaluating their algorithmic offering in the futures space, by combining it with other offerings on the execution and clearing front.

“The big banks will look to capitalise on their scale offer a platform of services which their HFT competitors cannot offer. For some of the bigger buy-side firms, it may be beneficial to execute their futures trades with the big banks even though someone else is faster because of the package of services the banks will offer,” says Gilmore.

To an extent, Gilmore says that algorithmic trading is now becoming less about speed, and more about what other value-added services banks can provide.

TT’s Rick Lane agrees, as speed in the futures market is not as vital as it is in other markets such as equities and cash treasuries.

“Speed is important, but what is often more important is having intelligent decision making tools. To an extent, in the futures market it is often less about speed and more about deploying algorithms that are capable of acting upon large amounts of data,” Lane says.

As a result, the perceived ‘arms race’ between banks and high frequency trading firms has, to an extent, come to an end as technology becomes more accessible to people.

“I don’t feel there is necessarily an arms race between banks and other high speed players. These new players are coming to the market and either focusing on a very specific part of an asset class, or there are ones that are being quite generic,” adds D’Erasmo.

There is also a possibility that the new entrants might look to partner with the banks to grow their algorithmic coverage.

“The rest of the firms [new entrants] may come to the conclusion that they can’t compete on technology or speed any more, and may take a money management approach whereby your view in the marketplace outweighs speed to the marketplace,” explains Gilmore.