So, where do we stand?
For foreign exchange traders, the market has grown in terms of electronic prowess and innovation from where it was just a few years back. While the sector is one of the busiest, trading virtually every day and all day, it has lagged its equities brethren when it comes to homogeneity and technology, such as algorithms.
But alas, not so much anymore.
According to the latest triennial survey by the BIS, volumes in the forex market noted a decline in volumes for the first time in 15 years. But after the slow-down in market activity, amidst the spate of regulations for the FX market, it is likely that the worst may be behind it.
But what about the state of technology?
As we look to the future, there is real opportunity for heads of FX desks to take stock and consider adjustments to their technology strategy. Recent research found that upgrading technology can have a profound effect on the FX business – reducing costs by improving operational efficiency and increasing market share by competing more effectively, said Vikas Srivastava, Integral’s Chief Revenue Officer. Banks have relied on legacy systems to manage their workflow for too long, opening the potential for unnecessary complexity and the increasing exposure to technology and business risk. Ensuring the right tech stack is selected requires a fresh outlook if banks are to harbor hopes of capturing optimal flow when volatility returns.
The leaders of tech innovation, companies in Silicon Valley, have long operated under a policy of only deploying better, faster, cheaper technology, in a bid to increase market share and retain clients. Could this mindset, Srivastava wondered, if it were to be embraced by the FX markets, have a similar effect on the trading desks and act as an enabler for growth?
In terms of making things better, cloud-based tech has the unique ability to deploy enhancements to the system for the benefit of all users, he said. This cumulative wisdom from the broad swathes of the industry results in a more complete, comprehensive stack and high-performance functionality. Importantly, cloud systems are easily configurable, so the user can still deploy unique workflow and leverage what they deem to be their secret sauce.
And what of algorithms?
Bulge bracket broker JPMorgan was most recently in the news upgrading its forex algorithms by making them are getting smarter – all the time. Think Skynet from the Terminator series of movies of HAL from 2001 A Space Odyssey,
JP Morgan technologists are now incorporating machine learning technology that reviews previous trade performance and applies lessons learned. In an interview with Reuters, JPMorgan explained that its new algorithm – named DNA or Deep Neural Network for Algo Execution – effectively combined what a multitude of algos currently do, into a single strategy and allowed the framework to judge how a client order should be executed.
For example, a typical time-weighted average price order executed by an algorithm may aim to buy a particular amount of currency over a few minutes or hours. But if the order is not executed within that time frame, the machine will trade aggressively toward the end to buy the required amount.
The new algo aims to take that decision-making process one step further by determining on how best to execute the transaction, based on results of past trades.
The objective of an algo is to minimize market impact by executing in an efficient and timely manner, Chi Nzelu, head of macro eCommerce at JP Morgan said. What we have done is establish a neural network using a machine learning technique which determines how to place the order, at what price and execution style.
And what of cryptocurrency? Does it trade as often as legacy currency and who wants it?
According to new research from deVere Group, the wealthy are looking to increase their cryptocurrency exposure. The firm said that more than two-thirds of high-net-worth individuals will be invested in cryptocurrencies in the next three years.
Carried out by deVere Group, a proprietary survey revealed that 68% of poll participants are now already invested in or will make investments in cryptocurrencies, such as Bitcoin, Ethereum and XRP, before the end of 2022.
The research was based on responses from over 700 clients who currently reside in the U.S., the UK, Australia, the UAE, Japan, Qatar, Switzerland, Mexico, Hong Kong, Spain, France, Germany and South Africa.
High net worth is classified in this context as having more than 1m (or equivalent) in investable assets.
There is growing, universal acceptance that cryptocurrencies are the future of money – and the future is now, Nigel Green, founder and CEO of deVere Group told Traders Magazine in a phone call. “High net worth individuals are not prepared to miss out on this and are rebalancing their investment portfolios towards these digital assets.
Green added that crypto has several distinct qualities making it more interesting than traditional currency trading and could be the future of foreign exchange.
First, cryptocurrencies are borderless, making them perfectly suited to an ever globalized world of commerce, trade, and people, he began. Second, they are digital, making them perfectly suited for the increasing digitalization of our world, which is often called the fourth industrial revolution. Third, they provide solutions for real-life issues, including making international remittances more efficient, and help bank the worlds estimated two billion unbanked’ population. Fourth, demographics are on the side of cryptocurrencies as younger people are more likely to embrace them than older generations. And fifth, institutional investors are coming off the sidelines and moving into cryptocurrencies, bringing their institutional capital and institutional expertise to the crypto market.
Global Code of Conduct
Traders Magazine recently caught up with Dan Marcus, Chief Executive Officer of ParFX, who discussed how his firm fits into this unique ecosystem – how it is helping shape the FX Global Code of Conduct and ParFXs technology designed to make trading more efficient and fairer.
ParFX is underpinned by four key pillars that support an equal and transparent trading environment that promotes responsible trading behaviour. These include a meaningful randomized matching methodology, a transparent post-trade environment, distribution of market data in parallel at no extra cost and a flat and clear fee structure with no special discounts, Marcus said. A series of platform upgrades, product enhancements and expansion plans mean ParFX will continue to build on its success in 2019. This includes the distribution of faster market data for our customers at no extra cost, exploration of DLT for credit management, the ability to execute smaller trade sizes and expansion to regions and currencies where our customers and prospects believe disproportionate levels of disruptive trading behavior occurs.
ParFX has been engaged in formulating and commenting on the FX Global Code of Conduct, Marcus continued. His firm has been engaged in proving input into the Code and the priority areas such as cover and deal trading activity, disclosures and buy-side outreach.
We were one of the first to sign up to the FX Global Code and our chief operating officer, Roger Rutherford, has been involved in the establishment of the Code as a member of the ACI FX Committee. I am also a part of the FMSB committee on eTrading: Trading Rulebooks and System Outages, which sets the standards and behavior for trading counterparties across a broad range of FICC markets, Marcus explained. From our experience, we have seen greater levels of debate and discussion about the Codes application between banks, trading platforms such as ParFX, vendors and clients. There has also been an uptick in interest from prospective clients, as our trading model is underpinned by a fair, equal and transparent trading environment.
He added that there has been good progress made in terms of adoption, with over 500 participants now signed up to the Code. Survey results released by the Global Foreign Exchange Committee (GFXC) recently showed that 95% of respondents had read all or part of the code and that the majority of respondents thought the Code had made a positive impact on their firm and the market.
And as the FX sector has evolved, ParFX, like ts distant equities exchange cousins, has had to contend with predatory traders and has introduced a speed bump or pause to level the playing field. Marcus explained that ParFXs randomized matching methodology replaces the concentration on speed with a focus on intelligence and strategy. By removing the speed advantage as a key factor of success there is a renewed focus on trading behavior, with greater quality and certainty of execution. We go with randomization.
His randomization model, developed in conjunction with the market, pioneered the use of randomized matching technology.
In other markets, some platforms have introduced latency floors and slowed down or batched orders, but these measures dont effectively deter disruptive trading behavior, Marcus said. True, meaningful randomization happens at an order entry level and applies to all trading elements, including submissions, amendments and cancellations. This consistent approach has proven itself to be a legitimate tool against disruptive low-latency trading strategies and successfully creates a market of genuine interest, reliable price discovery and firm liquidity. It is meaningful enough to nullify disruptive traders whose strategy relies solely on speed, and prevents abusive practices such as rapid order submission and cancellation prior to execution. However, it remains meaningless to those that have a genuine trading need, seek firm, executable liquidity and compete on strategy.
The following article originally appeared in the May 2013 edition of Traders Magazine
Forex Trading Getting ‘Equitized’
By Gregg Wirth
Foreign exchange and equities are two distinct asset classes, each with their own set of trading procedures, customer demands and levels of execution.
But that is not stopping trading desks at the nation’s largest asset management firms from nudging the two closer together. Often at the behest of clients, asset managers are coming to the realization that trading in these seemingly disparate types of financial instruments needs to be at least synchronized, if not also overseen by the same trading desk.
“It’s really a radical transformation of FX as an asset class,” said Will Geyer, head of order and execution management systems at ITG, an agency-only broker. “It’s a natural trend and points to the sophistication of the FX process and the desire to bring the thought leadership in equities to the growing FX operations.”
The reasoning behind this push, several trading firm executives told Traders, is to better harmonize equities and FX trading. Working the two in concert offers the best of equities trading-transparency, low-cost and rapid-fire electronic execution-in the firm’s currency trading operations.
In effect, asset managers are starting to “equitize” the FX side of the trading ledger. This means creating an FX trading operation that comes to mimic equities trading with competing electronic trading platforms that offer low transaction costs, high speed and greater transparency.
In practice, algorithms designed for currency trades can scan for the best price and execute instantaneously in quantities determined by a trade schedule. The algorithms bring the promise of lower costs and efficiency to the end user, Geyer noted.
This is already true in FX trades done in tandem with equity side transactions that involve foreign securities, according to Mark Kuzminskas, director of trading at Robeco Investment Management. For example, if you have a customer trading in Japanese securities, chances are they’re going to be sitting with a serious position in yen, to back up that trading. Those buyside firms want to manage that exposure on the FX side, and lock in profits on a trade at the best possible exchange rate. “Lots of investors are playing with the FX part of the trade that way,” he said.
The move is also an overt attempt, the executives added, to bring the best practices of equity trading-such as algorithmic trading, superior order flow and execution via ECNs, as well as a focus on transaction-cost analysis-to the FX side of the business.
In the most concrete examples, some of the largest investment managers have made their heads of regional equity desks take on the additional role of heading the firms’ FX desks. Vanguard Group, the largest mutual fund firm, has had its equities trading desk chief handling FX desk duties for the past few years, said Vanguard spokesman David Hoffman.
“We agree FX is starting to develop like the equity market,” Hoffman said. Vanguard, for instance, has made it a priority to use transaction-cost analysis to guide clients’ trading and routing strategies, with the goal of matching a client’s objectives with a particular trading style. “That said, on which desk the trading is actually done is not that important.”
The movement toward better equity-like execution on the FX side makes a lot of sense, said James J. Angel, a visiting capital markets professor at the University of Pennsylvania’s Wharton School. “The rest of the securities universe is going to get equitized,” Angel said. “All the innovations that we’ve seen in the equities market are going to spill over to the rest of the asset world, both domestically and internationally.”
Algorithmic trading, which currently represents just about 5 percent of FX trading, is one area where an equities-style execution could greatly improve the FX trading paradigm, Geyer maintains.
Given the low level of algorithmic trading on the FX side, there is enormous room for growth if FX traders strive to emulate their equity counterparts, where more than 50 percent of equities trading is now done through algorithms, according to data from industry research firm Tabb Group.
“The trend could optimize the life cycle of execution by using the guidance of the equity side,” Geyer noted, adding that this “life cycle” includes the process in which the trade data is captured, analyzed and implemented as a set of trade strategies. The cycle is repeated to tweak and optimize the end results.
Increased use of electronic platforms is a natural fit for FX, said Robeco’s Kuzminskas. “It makes tremendous sense from the point of centralizing the whole trade relationship,” he told Traders Magazine.
Indeed, while executives such as Geyer and Kuzminskas theorize that this push is being led by customers seeking more equity- and FX-linked trading strategies, there is another factor involved: regulatory change that is encouraging more transparent and modernized trading platforms.
This changing landscape in terms of the growing modernization and multiplatform electronic trading is being quickly ushered in by new regulations, such as Regulation NMS. The National Market System rules established in 2007 by the Securities and Exchange Commission were intended to “modernize and strengthen” the nation’s equity markets, Angel said.
“It’s a Reg NMS world now,” he said. But a full embrace of algorithmically driven execution of trades in non-equities asset classes such as foreign exchange will not happen overnight, mostly because of regulations governing differing asset classes.
“But because FX is so easy to monitor, every buyside investor who is not doing [transaction-cost analysis] on its FX strategy runs the risk of being found negligent,” Angel said. “There is an FX component on almost every trade, and asset management firms have to be careful that they are treating that with the same care as they are the equity trade itself.”
Special FX
Many of the largest asset management firms, such as Fidelity Investments, BlackRock, Vanguard Group, State Street Global Advisors, JP Morgan Asset Management and others, acknowledge that in certain circumstances, customers’ FX trades need to be handled in tandem with their equities trades and that those trades have taken on increased importance.
Many of the firms have taken steps within the past year or so to better synchronize trading in the two asset classes, even moving some personnel around to give FX the benefit of increased equity trading oversight.
Fidelity Investments also has recognized the synergies between the electronic markets in equities and FX, according to spokeswoman Sophie Launay, and has moved to structure the two trading operations similarly.
Obstacles to the increasing linking and automation of trading equities and FX exist. These mostly come from the largest global banks, such as Deutsche Bank, J.P. Morgan or Barclays, which would see their strongly entrenched positions as foreign-exchange trading titans displaced under a dispersed and fully automated FX trading environment.
The situation is similar to that of the New York Stock Exchange market makers in the 1990s, who didn’t want to give up their turf either and were in no hurry to be displaced by electronic exchanges such as the Nasdaq Stock Market, said Angel.
There, those electronic participants-such as Knight Capital Group-who were able to understand the changing market and embrace the new technology were able to adapt and flourish. “Frankly, FX pricing is an easy thing to do and an easy thing to monitor,” Angel explained. “And large investors are realizing that the banks may not be giving them the best pricing.”
Indeed, State Street and BNY Mellon are currently defending their FX trading fees in court against accusations from several state pension funds that the banks promised low-cost FX trading, and then inflated their profits with hidden markups. Both banks have said the pension funds’ claims are without merit.
State Street’s own exchange-traded fund and investment management operation, State Street Global Advisors, agrees that entrenched interests may slow full synchronization of equities and FX, unless such melding of trading operations is mandated by regulators, like the SEC.
“However, I think the SEC has other things on its plate right now,” State Street spokeswoman Alicia Curran said. “But I think most traders would like to see it happen.”
At State Street, there are three regional heads of equities, in the U.S., Asia-Pacific and Europe. Each head oversees all asset class trading, including FX, and all act under the firm’s global head of trading, Chris Rice.
While State Street Global Advisors, trading is still a smaller operation (fewer than 100 traders), it is moving toward common platforms, something Curran said is an industry goal.
Separately, State Street eExchange, which is part of State Street Global Markets, a brokerage division, also created two electronic FX trading platforms, FXConnect, for limited institutional use, and Currenex for retail use, Curran said.
“Everybody would like to see FX get more electronic execution, but sometimes, you just have to pick up the phone and call J.P. Morgan because the electronic volume is not there,” Curran said.
