The use of algorithmic execution tools in foreign exchange is set to increase significantly in 2017 as market conditions drive currency managers to seek increased efficiencies in trading, according to the findings of a comprehensive client survey conducted by JPMorgan.
In November, the US bank surveyed nearly 200 institutional FX traders, of which 38% said they were planning to increase their use of algos this year.
By far the most popular strategies are liquidity seeking and limit-based algos, followed by algos pegged to particular fixes and benchmarks.
Given low volatility in many currency pairs and a challenging trading environment, algos are being used to reduce the cost of execution, says Richard James, co-head of markets execution for macro products at JPMorgan.
“It has been a tough environment for many currency funds, so fund managers are now much more focused on execution costs, which in turn has contributed to the growth of algo usage,” he explains.
The increasing sophistication of transaction cost analysis (TCA) enables buy-side traders to take control of their execution costs, as they can identify those channels that are most effective on a pre- and post-trade basis.
Earlier this year, JPMorgan became the first bank to grant its clients access to the TCA provided by start-up technology provider BestX.
However, independent TCA such as that provided by BestX must be combined with in-house analytics that can support the client right from the selection of an algo through to real-time performance monitoring and post-trade analytics, according to James.
“The demand we see from clients is for help with algo selection on a pre-trade basis, tracking and alerting them if an algo is not performing to benchmark during execution, and then providing the post-trade analysis,” he says.
“We are one of the few institutions that can provide all of this as part of our core algo services.”
Separate research conducted by Greenwich Associates in late 2015 also identified a shift towards algorithmic trading and TCA to drive greater transparency and accountability in the wake of the FX benchmark scandal.
However, Greenwich noted that last year the technology is still developing, and predicted adoption would increase as the tools mature.
The OTC FX market is very gradually becoming more electronic, but the JPMorgan survey appears to be more reflective of a group of buy-side firms than the overall FX market
- Javier Paz, Aite Group
Among the most common issues and challenges facing buy-side traders today, the JPMorgan survey found that market volatility and availability of liquidity ranked at the top, closely followed by global political and economic uncertainty.
Commitment to electronic trading appears to have remained robust, however, with 76% of trading volume predicted to go through electronic channels this year and 31% of respondents saying they are likely to use a mobile trading app.
The average number of e-trading platforms on a buy-side trading desk is 4.4, while 36% of firms say they use only single-dealer platforms.
“The survey clearly highlights how competitive this space remains for single- and multi-bank platforms and liquidity aggregators,” says James.
“Many buy-side firms are clearly using different platforms for different functions, but we believe that the key differentiator for banks lies in real and consistent investment in the full front-to-back lifecycle for FX cash, swaps and options.”
The survey also asked firms why they choose to use particular platforms. While competitive pricing was inevitably the first response, 38% cited depth of liquidity. A further 30% cited ease of navigation, which might justify the investment many platform operators, including JPMorgan, have made in their user interfaces in recent years.
However, despite the enthusiasm for electronic channels that the survey indicates, it might not fully reflect broader market trends.
The Bank for International Settlements’ triennial survey of FX market turnover was conducted last year and found that average daily volume conducted over direct and indirect electronic channels amounts to nearly $2.8 trillion.
This accounts for at least 55% of total global turnover on a daily basis, but is not quite on a par with the 76% of volume that JPMorgan’s clients expect to go through e-trading channels this year.
Javier Paz, Aite Group
“The OTC FX market is very gradually becoming more electronic, but the JPMorgan survey appears to be more reflective of a group of buy-side firms than the overall FX market, in which many firms continue to use direct and indirect voice methods to execute trades,” says Javier Paz, senior analyst within the wealth management practice at Aite Group.
While 54% of JPMorgan respondents’ time is currently spent on FX cash products, this is expected to rise by 24% in 2017, and options usage, currently at 17%, is projected to rise by 39%. However, Paz believes TCA and best execution will remain at the top of the agenda.
“The FX spot market has been somewhat sleepy over the past few years and I think most traders in the western hemisphere have been engrossed in the complexities of best execution, TCA and, to a lesser extent, regulatory compliance,” he says.