The rise in the number of high frequency trading firms in FX markets has had an overwhelmingly positive effect on market liquidity, rather than a detrimental one, a veteran hedge fund manager told Euromoney's Forex Forum last week. Some are even offering prices to hedge funds and other asset managers directly, bypassing the need for them to do business on banks’ internal platforms, in some cases.
“The more high frequency traders you have, the more liquidity you have,” said Richard Morrish, a fund manager at Peak Partners, based in Geneva. “You can attract the bigger HFT players to execute with you. To me, they're a godsend.”
Bank for International Settlements data shows that most of the recent FX market growth, about 20% in volume terms in the period between 2007-2010, was due to the increase an trading from HFT players. In their review of the market late last year, they estimated that 25% of FX activity, or as much as $375bn per day, was from that trading type, though it couldn’t verify the figure.
The debate about whether HFT firms enhance price activity in the currency markets has been a hotly contested one in recent times, after their proliferation on some trading platforms, such as EBS and Reuters, led a group of leading FX banks to consider the possibility of forming a bank-only trading platform, called Purefx.
They argued that HFTs had the ability to game the marketplace, because their trading technology gave them a millisecond’s advantage. EBS has, over the past year, introduced a series of initiatives that allows bank traders to effectively compete with high frequency traders, by automating many discretionary parameters and execution functions.
Among these new features are pip discretion, SWAT, continuous match and fixings. According to Steve Toland, head of EMEA FX sales at EBS, 40% of the firm’s underlying volumes come from high frequency trading. He says the inter-dealer broker is spending increasing amounts of its time educating customers on the subject, and helping better use the new functionality when they trade with HFT traders on EBS.
These funds have also begun to spread their liquidity across a wider array of electronic trading venues. Mark Warms, general manager, EMEA, at FXall, this year’s top-rated multi-dealer platform in the Euromoney FX survey, says that there was “no question” that his platform had seen a dramatic increase in high frequency trading volumes. He also argues that high frequency traders helped disperse liquidity in the market. “In the old days, it was concentrated among the big banks,” he said.
Peak Partner’s Morrish compares the HFT situation to the exchange-traded futures markets in the 1980s, when locals – self-funded proprietary traders operating on an exchange floor – helped add liquidity in sluggish low-volume contracts.
Asked whether he thought HFT firms were in effect becoming mini-banks by acting as market makers, FXall’s Warms said: “No question, they're competing with the big banks in market making.” Nonetheless, keeping all of their various client-types happy is never easy. “The challenge for us is to serve them while agreeing fair rules of engagement,” argues Warms.
Indeed, Icap’s Toland, argues rules, such as minimum quote life, for orders placed on its system, had cushioned the impact of currency volatility on EBS, during last May’s flash crash, when the Dow Jones Industrial Average plunged 900 points in 10 minutes. While in the equity markets, the Securities Exchange Commission has been working with stock exchanges and the Financial Industry Regulatory Authority to develop a system of so-called circuit breakers to moderate excessive volatility, Peak’s Morrish argues that they were unnecessary. “I don't think we need them,” he said. “Invariably when regulators attempt to correct a problem, they create a new one.”