E-FX Outlook: Automation on the Rise
DWT:
What will be the greatest technological challenge for e-FX dealers in 2008?Ian Green, head of e-FX, Credit Suisse:
The primary challenge for each e-FX dealer is to figure out where its own distinctive expertise lies. Trying to be everything to everyone is increasingly complex and expensive, and for many e-FX services there are really only a few credible names. As the e-FX marketplace matures the profitability of generalists will come under intense pressure.Jon Healey, head of e-commerce FX EMEA, HSBC:
Responding to lower-latency requirements and the even greater complexity that liquidity fragmentation has introduced to automated hedging will be key. Following on from this will be the need to provide such capabilities and transparency of strategies to customers for electronic order execution. I suspect that a major challenge will be the ever-increasing transaction volumes and especially the burst nature of the traffic. Facilitating real-time pricing and execution into cross-product multi-leg execution in an increasingly competitive space will also be a major challenge for next year and beyond.Karsten Strobaek, principal developer, STP and business-to-business services, Saxo Bank:
As spreads get tighter and tighter, it is going to be increasingly difficult to make a profit. Smarter systems and lower latency, together with increased scalability will be required to stay ahead of the game. We believe these are some of the challenges we will face in 2008.DWT:
How will your firm address this?Healey, HSBC:
We will continue to address the key issues of latency and algorithmic development along with the evolving FIX specification, while remaining cognizant of the new developments and platforms, which are a regular feature of the FX marketplace.Strobaek, Saxo Bank:
We have several projects under way to address exactly these things: lower latency, higher performance, smarter trading. Down the line we may look toward distributed datacenters and possibly even regional price generation and trade acceptance measures.Green, Credit Suisse:
At Credit Suisse, we believe our expertise lies in tailoring the most sophisticated services and our plan is to offer them in forms that have distinctive excellence and, essentially, client convenience.DWT:
What is the state of algorithmic trading when it comes to the multi-legged trade environment?Healey, HSBC:
Multi-leg algorithmic trading is not the most common form of execution that we see at HSBC for FX. Although common in equities and fixed-income trading for some time, it has only recently begun to become evident in FX. However, that it is not evident does not mean it is not taking place. Indeed, the multi-leg activity may occur across several bank systems, so each bank may only receive a single leg, thereby obfuscating the intention. In arbitrage scenarios, multi-leg activity is most likely to be divided deliberately in this way in order to hide the true nature of the activity from the market-makers. Multi-leg activity in single products is now likely to be relatively common, but seen more often in arbitrage and much less in hedging mechanisms.Strobaek, Saxo Bank:
It's hard to make a general comment about the state of algorithmic trading, because there are many different definitions. If we are talking about black-box trading, we believe that the market is growing. Firstly, it has become simpler to tap into liquidity, due to standards like FIX. But growth is also being driven by the increased use of quantitative analysis and technology in trading, as margins get tighter and tighter.Whether or not banks are going to see an increase is difficult to determine. We see a tendency to move away from the liquidity pools, where the banks have to offer anonymous liquidity, and more toward personal relationships between the liquidity provider and consumer. With that said, we expect to see growth in the use of black boxes. Put simply, they scale better than people do, and companies have the option of utilizing automated hedging.
Green, Credit Suisse:
People continue to run models and proprietary-trading strategies that span multiple markets as they have for many years. Recent developments are now making it easier to place trades intelligently and electronically for a variety of asset types once the decision to trade has been made. At Credit Suisse, we are offering clients the ability to place instructions for algorithmic executions across cash equities, equity and interest rate futures, options on these, and foreign exchange (FX). We market these under the Advanced Execution Services (AES) umbrella.The AES proposition, which is new outside of equities, is that clients will sometimes pay for the advantage of executions that are invisible even to our own market-makers when costs can be rolled into the all-in dealt rate and calibrated to be clearly lower than the execution improvements they get from the use of algorithms and increased access to liquidity. Our most recent innovation in FX options-delivered on our new Merlin platform-is to give our clients the ability to buy and sell a wide range of complex strips and structures on an autoquote−autodeal basis with full straight-through processing (STP). These routinely have more than 100 legs and require no human intervention.
DWT:
What do you see as the prime driver or hindrance in its uptake?Green, Credit Suisse:
The attractiveness of these innovations is that our trading desk can delegate the need for their constant intervention in routine activity to electronic processes that are frictionless for the client. For the user of execution algorithms this enables them to trade efficiently and intelligently against a large aggregated pool of liquidity without being seen. For clients dealing in options it simplifies the client-sales-trader chain and facilitates a quick and iterative process of structuring and pricing.Healey, HBSC:
The prime driver is to provide access to greater liquidity and thereby price improvement through the combination of both vanilla and synthetic products. From the perspective of the market-maker this provides the basis for efficient hedging strategies and for arbitrage activity a mechanism to seek out and secure a guaranteed profit. What stands in the way of building these types of mechanisms is the complexity that comes from executing across multiple execution venues, each with their own different patterns and probabilities of fill, and the added difficulty of managing risk if one or more legs fail. Moreover, without sufficient focus on reducing latency to an absolute minimum, multi-leg strategies are simply ineffective. This combination of complex requirements, legacy generalist architectures, and very high-cost barriers will mean that few participants will be highly successful in this space.Strobaek, Saxo Bank:
Its growth is being driven by FIX messaging standards that support algorithmic trading and increased use of quantitative analysis in trading to improve spreads. Potential barriers could be the rejection by banks that find it hard to deal with high flows and cut-throat price arbitrage.DWT:
Will complex event processing (CEP) play a major role in e-FX trading?Strobaek, Saxo Bank:
Often, execution speed is mentioned as the most important factor when talking about e-FX trading. However, fast execution is worth nothing if, for example, the reject rate on the trade requests is too high. Players who stand to win this game are the ones with fast execution and low reject rate. One way to achieve a low reject rate would be to make the margin and credit check before streaming out the quote, and then take this into consideration during the price generating process.The volume generated by e-FX trading is minimal compared to the volumes of futures and equities trades, so we do not foresee any problems with taking the orders and quotes into account in processing them.
Green, Credit Suisse:
The majority of banks that stream executable prices already form these prices and hedge some portion of the arising trades using algorithms. These algorithms either explicitly or implicitly implement complex event processing paradigms. The question is whether it's done well or badly. The same is true of high-frequency prop trading.Healey, HSBC:
With the advent of higher levels of FX trading, in general and with further increases in algorithmic trading, it is inevitable that human traders will not be able to react at the same speed as a machine to either exploit arbitrage opportunities or deploy active hedging strategies. As newer technologies enter this field, such as machine-readable news, it becomes even more critical that a significant number of events will need to be understood in order to deploy the correct strategy. It is important to note that this will not be an activity in which human traders are absent. On the contrary, a trader's role will change to one where the trader instructs the CEP programmer as to how react in a set of circumstances and to change execution parameters on the fly.DWT:
How much traction do you see the FIX messaging protocol gaining in the e-FX market?Strobaek, Saxo Bank:
FIX has, for many years, been the de-facto standard used for order routing and is fast becoming the same in the e-FX space. With the newer versions, FX trading is fully supported and most tier-one banks are now utilizing FIX in their e-FX offering.Green, Credit Suisse:
Banks who supply prices generally prefer proprietary protocols as these can be optimized to their own data and infrastructure. However, institutions and trading venues that subscribe to prices from many sources clearly prefer to have one protocol that can be used for most or all of them, even if it isn't optimal for any single one. Here, FIX is the only game in town and has consequently seen a significantly increased pace of adoption over the past three to four years. The FIX protocol itself has evolved in response to this, adapting from its original equities orientation, and is emerging as the standard. This is true for cash and options.Healey, HSBC:
FIX is the predominant protocol that we see in FX. It is far beyond evaluation stage and well established as the protocol of choice. Any initial concerns about speed are being eroded with the experience of use. Further advances in the FIX protocol, such as version 5.0 and FIX Adapted for Streaming (FAST), will complete many of the required gaps and establish FIX as the immediate first choice.The use of a common communication language, which FIX provides, is an obvious win for the industry and very clear to anyone at the sharp end of the connectivity problem. As multi-leg cross-asset strategies become common, FIX will become even more crucial as the method by which institutions trade.
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