Nicola Tavendale

From market penetration to product evolution: Key FX algo trends to watch out for in 2023

June 2023 in Industry Views

One of the most encouraging take-aways from The Finance Hive Global Pulse: FX Algos & Automation Tech and Talent was the clear buyside opinion that current market provision of FX algos is of a high standard, with some 52% of firms reporting that they were very satisfied with their algo providers. This is likely to be due in no small part to some of the key trends seen over the past year, including a near market-wide push to focus on improving the user experience for algo clients.

Towards the end of the year in particular, there was notable shift away from adding new bells and whistles to algos and towards a greater focus on performance, says Dr Ralf Donner, Head of Marquee Execution Solutions at Goldman Sachs. “That in turn was brought about by a very different approach from clients as well,” he adds. “Clients are now increasingly looking at both bank provided as well as third party transaction cost analysis to try to determine the quality of their algos and algo providers. They’re looking at individual performance in a much more detailed way than they ever had previously and this has meant algo providers are focusing to a greater extent on making sure that performance is top notch.”

While algo providers have probably now gone as low as they can on fees, Donner believes that they will now need to focus more on improving the variable cost which comes from how they interact with markets. In addition, he notes that over the past year, a number of banks were hit by new SA-CCR regulations that affected the quality of swaps pricing – resulting in a sort of a scramble to try to improve on the forward points for algos. “This has been possible because the outrights can be treated differently from swaps due to the spot component. But either way, it has meant that clients are far more focused on forward points and swaps and are starting to look to a greater extent at that component of their algo execution.”

Impact of recent trends

Donner explains that by gradually accumulating the forward points over the course of the execution, this can lead to a potentially better outcome for clients. He adds: “This change isn’t particularly visible to clients and their execution continues as normal. We’re not waiting to the end of the trade to find the points but we’re sourcing them through the lifetime. So seemingly nothing has changed but it’s a revolution behind the scenes.” Another way that this could have a positive impact on outcomes for clients is for those with currency pairs, such as NDFs, where one month is not so liquid and there might be a correlation between trading the one month and trading the intended broken date. “By the way anything that’s highly correlated, it will probably be better to execute the two or more things together using our basket orders instead,” Donner says.

Customisation has also been a key trend in FX algos due to the benefits it provides, says Harshad Hariharan, FX algo product manager at JP Morgan. This has included improved time to market for new products and features, or simplified workflows, with parameters already pre-configured so clients no longer need to repetitively set all algo parameters for each execution, he explains. In addition, the market is undergoing a period of increased volatility and the cost of errors can be high, so stability is now very important, Hariharan warns. “In situations where the multi-dealer platforms have an issue, the ability to provide transparency and control of orders through tools such as Algo Central will be extremely helpful,” he says. According to the results of the most recent J.P. Morgan e-trading survey, half of all respondents rated ‘volatile markets’ as their greatest daily trading challenge in 2023. “Volatility increases costs and makes the use of algos even more appealing. During volatile times, when liquidity has historically been a challenge, having an extra tool in the form of algos to extract liquidity is a valid proposition,” Hariharan adds.

Over the past year NDF algos also gained momentum, according to Hariharan, with significant increases seen in volumes. “The continued demand from clients for parity between the NDF and the deliverable algo offering points towards further volume increase in 2023” he adds. “We will be working on achieving parity between the NDF algo and deliverable algo offering this year in terms of strategies, features and analytics.” The more sophisticated Market Tracking and Twap algos were more widely used in the NDF pairs in 2022, Hariharan adds. “Not only have J.P. Morgan client NDF algo volumes grown 5x in 2022 vs 2021, but there has also been a significant increase in the usage of analytics tools for NDF pairs – such as Market Structure – over the course of 2022 to better understand liquidity conditions in these pairs,” he says.

Focusing on the client

“Clients are now increasingly looking at both bank provided as well as third party transaction cost analysis to try to determine the quality of their algos and algo providers.”

Dr. Ralf Donner

Over the last few years, J.P. Morgan has also been invested substantially in refining the algo analytics data that it offers to clients, Hariharan adds. “We have seen substantial increase in clients using J.P. Morgan’s algo execution and analytics tool – Algo Central. The next step here is to now allow clients to set up alerts around the algo performance metrics that they track and get proactively notified when the algo performance deviates from expectation. This will in turn allow them to make better corrective decisions going forward,” he explains. Hariharan says that the aim is to enable clients to manage their third-party/API orders directly on Algo Central. “This will be a simplified workflow for clients that will also help with transparency and control during issues on third-party platforms. The enablement significantly shortens time to market of features developed by algo providers on multi-dealer platforms,” he says.

Historically, clients had typically not always evaluated algo providers based on data and performance metrics or did not have access to that data, says Preston Mesick, Global Head of FX Algos at Barclays. “We would like customers to be able to access and use this data so they can more accurately evaluate their algo providers based on performance,” he adds. “This allows clients to see how algo providers are either getting better or worse over time. We believe in offering our clients a low touch product but with high touch service and we want to make sure that customers can see this reflected in their algo analytics and performance metrics.” The challenge however can be that much of the data can look very similar, he explains, so it important to work with the customers to help them understand their execution performance and to inform better decision making around how to configure their orders and the impact of different parameters etc.

“The nature of markets is that they evolve and change,” Mesick adds. “Algo offerings across the street are going to continue to mature and part of that is there going to be new venues. Algos will have to adapt to understand the new liquidity environment and how best to interact with it. From our perspective, we’re investing heavily in building a process to allow us to adapt to those changes over time and make our algos better as they as the market continues to evolve.” Alongside this, Mesick says it is also vital to recognise the importance of the customer experience. This means focusing not just on improving the workflows and tools that algo clients have access to, but also in ensuring the relationship between the provide and client is in place to walk them through and understand any changes in the technology. “Customers are becoming more sophisticated and the level of conversations that we are having are becoming increasingly complex,” adds Mesick. “There’s a better understanding in the market because there’s more data available. to the market. All algo providers are going to have to continually up our game up in terms of our improving our offering and to increase the communication and transparency we have with customers.”

Areas of growth

Ajay Kataria, Head of Electronic FX Distribution, Americas at Barclays, agrees, adding that having a good understanding of how and why an algo provider is routing orders is also very important for customers. “Just seeing a bank’s name on a TCA report that they took down 20% of the algo isn’t all that helpful. Clients need to understand what internalization means in an agency style product so they can really make use of that data. Just because the bank name shows up or takes down more, doesn’t mean that that flow was internalized by any means,” he says. “That is why the human element is so important in FX algos. It is important to us to have that relationship with clients, to have those conversations and achieve a real understanding of the product.”

A further example of how important the human element is to Barclays lies in its relationships with charities, such as the fund-raising efforts of the markets business in aid of the Leukaemia & Lymphoma Society (LLS). “Last year we established ‘Commissions for Cancer’, where we donated all the commissions earned from our algo product for the day to support the important work that the LLS do. It is something that we as an organisation are very proud of and will be repeating the event again this March and extending it to more of our markets, not just FX,” says Kataria.

Although we typically think of algos as used by clients for trades, algos are also useful tool for internal desks as well, notes Donner. As a result, one interesting new development has been an increasing involvement with systematic trading strategies with some form of intraday execution, he says. “This is a growing trend and something that we see a lot of client interest in and of course, FX algos are a fantastic tool for executing that kind of automated view,” adds Donner. “It hits the market as a new index product that a client can invest in, but behind the scenes, what is happening is that our client algo products are being used to facilitate the hedging.”

“Later this year, clients can also expect a new visual pre-trade analytical tool inspired in part by our visual structuring App for FX Options,” says Donner. “As you build better analytics, the analytics can start to inform the algo and vice versa,” he adds. “There is a feedback loop that exists between the tools that we build to show clients on our dashboards, like the liquidity execution dashboard, and then on the other hand, the algo product itself.” Then in terms of regional growth Asia continues to be an important area for further opportunities, says Donner. “Last year, Asia really came to the fore with NDFs as that is the main liquidity period for these Asia NDF markets. Now we are seeing continued interest and growth in algos in Asia,” he adds.

The customer comes first

“During volatile times, when liquidity has historically been a challenge, having an extra tool in the form of algos to extract liquidity is a valid proposition,”

Harshad Hariharan

Looking ahead, continuing to improve the user experience will be an important and ongoing trend, Donner says. “Anytime you develop new technology, there is a tendency for it start simple and then it gets ever more complicated. At some point there comes a realisation that the front end is now so complex as to be a hindrance and it would be better to have something that was equally sophisticated on the inside but was easier to use. It is that ease of use that continues to be a strong push,” Donner says. The growth of FX algo usage in Asia has also been a very positive story for J.P. Morgan, says Hariharan. “Not only have algo volumes increased significantly, but clients have also matured in their usage of FX algos. This is evidenced by not just a 45% increase in J.P. Morgan client deliverable and NDF algo volumes in APAC but also the switch in execution strategies of APAC clients from traditionally being limit-based algo users to now being more comfortable using market tracking algos. Data has also become a key focus area in Asia and executions are scrutinised to evaluate improvements in line other regions and this trend will likely continue into 2023,” he adds.

In addition, Hariharan says that this year will see continued efforts to improve transparency on execution and algo workflows. For example, J.P. Morgan is in the process of rolling out enhanced “Trade Analytics” on Execute and Algo Central in the early part of 2023, he adds. “Based on past experiences at JPM, operational rejections also have a negative impact on client experience and it often takes quite a bit of time to correct the issues causing the rejections,” Hariharan says. “The ability to leverage pre-trade workflows to avoid rejections, have automated monitoring of rejections and minimise time spent in fixing rejection scenarios will go a long way in improving the user experience.”