Jeremy Carvell

FX algos: Looking beyond the Spot market

May 2023 in Market Watch

Jeremy Carvell, Head of Liquidity Sales EMEA at 360T, takes a look at the next frontier for FX Algo trading.

In a survey of 718 institutional and professional FICC traders conducted by JP Morgan earlier this year, 63% of respondents said that they expect to execute more of their trades via Algos in the future. In FX specifically, traders predicted an additional 19% of their overall flows will be traded by using Algos. The growth of FX Algos has been well documented, but there has been less attention paid to what types of instruments are being used to trade. This is probably in large part due to the – often implicit – assumption that when we talk about Algo trading we’re really talking about FX Spot. Fair enough, this is where the overwhelming majority of FX Algos have been deployed.
The Spot market is highly liquid (for the most commonly traded deliverable currency pairs) and there is a high percentage of volume executed electronically and across a range of channels and platforms.

But like all things in FX, the skills used to develop the Spot Algo market are being deployed to other instrument types which are now being requested by buy-side institutions and firms, most notably NDFs and Outright Forwards.

The potential cost savings for using an Algo in the NDF market can be substantial

The next step

Clients have been using Algos in the Spot market for many years. Through experience, trial and error and a proliferation of tools to help clients measure Algo performance, clients are well equipped to quantify the value which these products have delivered.

Given that clients can measure performance down to the currency pair, time of day and prevailing market conditions, there has also been a growing sense of comfort in their usage. And with that, clients now look to see how they can use the same tools across other instruments.

Which explains why Forward and NDF Algos are proliferating, too. Especially in the less liquid instruments, there is an opportunity to benefit. The potential cost savings for using an Algo in the NDF market can be substantial. Electronic but less liquid markets like the major NDF pairs mean there is an opportunity for Algo users to minimise transaction costs while reducing signaling and information leakage through the adoption of strategies that allow for adjustment to the market environment. Lessons have been learned from many years in the Spot market. The growth in NDF Algos has been aided by a significant change in the marketplace.

Over the past couple of years we’ve seen multibank platforms — including 360T — broaden their NDF offering from not just RFS but to a streaming offering also. This is important because having liquidity pools of sufficient depth and quality is vital to ensuring the performance of executions Algos. And as NDF liquidity becomes more fragmented across multiple venues, Algos can deliver better execution outcomes by trading across them. Streaming in itself reduces signaling risk as only the receiver of the trade is aware of its occurrence. For large trades, in less liquid markets this soft approach is very important in minimising market impact.

A virtuous circle

NDF Algos are new but the genesis of them comes from many years of activity and experience in the Spot market. As the industry branches into traditionally less liquid markets it seems reasonable to expect a virtuous circle of increased liquidity, leading to more Algorithmic executions to increased liquidity. As this market matures there is no doubt that execution costs will continue to come down. Forward Outrights are another growth area of Algo execution which we see on 360T.

A solution for clients which want to hedge to a specific exposure date, combining the liquidity of the Spot market with the convenience of having the trade rolled to the appropriate settlement date. So what next? The direction of travel looks clear. Both Forward and NDF offerings are on the increase. 360T has already expanded Spot Algo integration to include forward and NDF with a dozen LPs. What’s more, we know Liquidity Providers are already turning their attention to the biggest market of all – FX Swaps – so certainly more of that to come.