European Securities and Markets Authority (ESMA), EU’s securities markets regulator, launched a consultation in December 2020 seeking input on the impact of requirements under MiFID II/MiFIR regarding algorithmic trading, including high-frequency algorithmic trading.(due 12/3/21)
In January this year, the GXFC Working Group on Algorithmic Trading and Transaction Cost Analysis (TCA) set out four areas of focus in the context of ongoing Global Code review:
- TCA and data availability
- Control mechanisms and liability around use of execution algorithms
- Identifying and managing conflicts of interest by Market Participants providing algorithmic trading services
- Improving disclosures and user education in the context of on-going review of the FX Global Code.
The online discussion was hosted by Stephane Malrait, Chair of ACI’s global FX Committee, and featured Tjerk Methorst, Senior Trader at PGGM Investments; Asif Razaq, Global Head of FX Algo Execution at BNP Paribas; Rich Turner, Senior Trader – Currency Solutions at Insight Investment and Christian Gressel, Head of FX Algo Trading, UBS.
Malrait began by asking the panel their thoughts on the proposed introduction of a standardised disclosure template for algo products. Razaq explained that such questionnaires were nothing new to the FX markets and algo providers in particular have seen a growing trend towards their use. “It would be good to have a regulated, standardised template in use,” he said, noting that some questionnaires he’d seen can run to 200 questions, which can be a burden on teams to complete. But he noted that the potentially controversial aspect of the cover sheets is what level of detail FX algo providers would be required to disclose. “It’s important that our clients can understand the inner workings of the algorithms,” Razaq said. “Yet from a competitive standpoint, service providers must be able to protect proprietary IP and the finer details of specific algo strategies. We fully agree with the spirit of transparency. We just need to be careful on how much detail is being demanded from the banks.”
Benefits of cover sheets
According to Methorst, buy side participants would also prefer disclosures to be open and public, whereas the sell side are concerned that full (public) disclosure could be both anticompetitive and potentially harmful, if made available to those unsuitable to use them. “It’s about balance,” added Methorst. “As a trader, sometimes I need to explain internally why I’m using certain algorithms or why I would like to trade with certain banks. If I have standardised data available, that would save me a lot of time.” Turner added that if the banks did have several hundred clients asking for a similar disclaimer, then it may be well be of benefit to make the answers to common questions publicly available for clients, such as on a website. “Algorithmic trading for me has been quite a long journey. You start that journey by asking some very basic questions, then over a period of time those questions become deeper and deeper depending on what you are trying to achieve. And it’s also a journey for the banks as well – essentially you want to make sure that the algorithm is suitable for that person to use,” Turner said.
With respect to measuring the performance of algo strategies, the panel were in general agreement that a standardised TCA template would also be a good thing and that benchmark standardisation would be of particular benefit to the buy side. Gressel noted that standardisation was important to clients because they want to ensure that whatever they’re comparing from different providers is normalised. He added: “With TCA, the difficulty for us as providers is that we need to be able to provide the data in the form that the funds are asking for. The fewer different ways clients are asking for data, the easier it’s going to get for us, but ultimately normalisation and data and standardisation is something that benefits clients because they are the ones that need to look at the data and then use the data in order to make decisions.”
Education and responsibility
Malrait then moved on to the question of control and liability and asked the panel if this was an area the FX Global Code should cover. Methorst explained that the buy side trader tends to want to have all the tools and to feel fully in control, but at the same time, tries to steer away from accepting the liability. He argues there is a benefit for the banks to educate algo users but it is also something that clients should be aware of as well. “Going forward, we will have more and more entrants to this market,” Methorst added. “I’m aware of what kind of liabilities I’m accepting by taking more control of the execution of our flows. It should be something that buy side traders are aware of.”
Similar to most other industries, technology providers that provide algo services have no liability if something goes wrong, explained Razaq. Yet in reality, the algo market is a relationship based service as well, he added. “If a client suffers a loss due to an algo malfunctioning, then the bank may look to compensate the client in order to protect the client-bank relationship even though our terms does not require us to do so.” said Razaq. “The overriding factor should be maintaining the client relationship.” The panellists generally agreed that the onus is on the algo providers to take responsibility for the actions of those who use their services, both in terms of market risk and in assessing the suitability of the algo to support the clients trading objectives. They felt that GFXC itself – and other industry bodies such as ACI – should do more to educate the market about opportunities, risks and best practices in algo trading.
In conclusion, panellists all agreed that going forward, a principles-based regime, such as that outlined by the FX Global Code, was the preferred approach.
Methorst felt that although he also preferred a principle-based approach, he felt it might be inevitable that the FX market becomes more formally regulated. “At some stage regulation will be required, at least to get a boundary line to where can you go,” he adds. “First of all, if you take a principle-based approach then it’s a matter of can it be enforced? Then the limits will be explored and at a later stage regulation is almost inevitable.”
Yet panellists agreed that the FX market functions well as it is with the FX Global Code and increased adoption of the Code adoption by all industry segments would realise even greater conduct and best practice benefits for market participants.