Navigating the choppy waters of EM currency trading with execution algorithms

June 2023 in Previous Features

The global foreign exchange may be the world’s most liquid market, with more than $5 trillion traded daily, but that liquidity is not always so abundant when it comes to emerging markets. Can execution algorithms help the buy-side manage uneven and sometimes chaotic market conditions?

China’s economic convulsions have reminded the market how volatile and uncertain emerging markets can be. As doubts have mounted about China’s ability to maintain economic momentum, a rethink of global macroeconomic conditions has begun, sending asset markets on a roller-coaster ride.

“I think algos in EM are incredibly important and I would argue that in some cases – obviously not all – illiquid markets are really where algos shine.”

Crises are never easy to navigate, but the recent tumult comes with a difference: it is taking place in a post-2008 world in which market participants say liquidity has been strained by regulatory efforts to rein in the financial industry. Despite the forex market’s size and depth, it has not been immune to liquidity concerns, and nowhere is that more the case than with emerging market (EM) currencies. Spreads on EM currencies have widened at critical moments, making trading more costly for buy-side participants.


But algo providers say execution algorithms may be able to help the buy-side in such choppy conditions. Some buy-side participants, rattled during times of market stress, may want to offload risk quickly and are willing to pay the sell-side to take on that risk. But algo providers say they could be unnecessarily costing themselves money

“There is absolutely a place for algos in emerging markets,” said Richard James, Head of Currencies & Emerging Markets Execution Services, at JPMorgan Chase. “A good algo should help reduce your execution cost. In some cases, a liquidity seeking algo might take longer to execute than just hitting a bank’s risk price or trading over the phone, but the algo’s ability to reduce the cost of execution can be much higher.”

While algo usage varies dramatically from one country to another, JP Morgan is finding that EM currency trading is seeing its fair share across the globe. “At the moment we definitely see clients increasingly using our algorithms in EM currency pairs across all three regions,” James said.

The JP Morgan executive said often the decision about whether to use algos for execution comes down to personal preferences rather than whether they will be effective.

“People are either comfortable using algos or they are not, but the number of active users we have is growing. JPMorgan were the first bank to offer USDCNH algos. We felt that the ability of the algo to seek liquidity, reduce the cost of execution and minimise any alpha leakage was exactly what our clients were asking for.”

Those who have low risk tolerance may feel more inclined to pay more to shift risk onto the sell side during stressful times but an argument can be made that this is precisely when algos can make all the difference by hiding the full amounts to be traded or sourcing liquidity in innovative ways.


Buford Scott, managing partner at Stelrox Capital Management LLP, trades emerging market currencies but the firm restricts itself to only those that are deliverable rather than NDFs since deliverable currencies have more liquidity.

“The deliverable emerging’s are less liquid than the majors but more than the NDFs. Depending which currency and what time it is, you can get some pretty good liquidity in the deliverables,” Scott said.

Stelrox Capital Management trades a wide variety of currency pairs, including South Africa-Turkey, Poland-Hungary, Hungary-South Africa, Britain-Mexico and numerous others.

“We’re trading algorithmically for the alpha. We trade lots of weird and wonderful currencies. We monitor about 150 currency pairs and we have positions in about 70 at any given time. So we’re matching them up in ways that probably a lot of people aren’t. Our objective is to diversify and have a very, uncorrelated portfolio of assets,” Buford said.

“Depending which currency and what time it is, you can get some pretty good liquidity in the deliverables,”

“We do focus on execution, but we are a smaller manager. Our volume isn’t so market-moving that we need to worry too much about algo execution. But it’s something that we do spend some time on and will probably spend more time on it as our AUM increases,” he said.

Scott said that the latest upheaval has definitely shaken some views in the market. But assuming markets calm down, he saw scope for more usage of algo execution in emerging market currencies. “I would say so, yes,” he said. Scott added that for deliverable currencies, his fund has seen generally good liquidity.

These comments came after some of the strongest EM currency volatility seen in some time, with the South African rand and other emerging units registering large declines in line with global stock market weakness.


James of JP Morgan says EM algos do present technical issues. “If you don’t have high levels of available liquidity overall it can be more challenging to offer algos in less liquid currency pairs. But for us we think it’s a real differentiator because of how our algos generally perform in illiquid markets and the value they can add as a result.”

A recent report from PricewaterhouseCoopers showed EM currency transaction volumes have grown since 2007, reflecting increase in investment inflows into EMs. Volumes have increased from $625 billion to just over $1 trillion, with the largest traded EM currencies being the Russian rouble, Chinese yuan, Hong Kong dollar and Mexican peso. Together these account for 40% of EM FX volumes, PWC said in its report.

Meanwhile, over the years, spreads on EM currencies have come down markedly. PWC said they had been some 14 bps wider than hard currencies but steadily narrowed and at several points between 2010 and 2013 actually traded at lower spreads. But EM economies, because of the strong relationship between immediate market activity and longer-term macroeconomics, present unique challenges.

The PWC report noted that emerging markets are highly dependent on global liquidity conditions, which provides EM economies with resources to strengthen underlying macroeconomic fundamentals. As a result, liquidity stress from advanced economies can affect emerging markets due to the large capital inflows they received during quantitative easing.

In other words, liquidity issues in EM countries can affect execution not only in the short term but they can lead to extended periods of market dislocation. Eventually, EM markets may be able to escape this relationship, but it could take considerable time. “In the longer term, emerging markets will develop their own domestic financial markets, but are dependent on international financial markets to make this transition,” PWC said.

All of this adds weight to the argument that FX algos can become an important part of a buy-side participant’s arsenal.

The PWC report noted algos have helped the wider FX market become more efficient. “The increase in liquidity aggregation that links liquidity pools via algorithms (e.g. by directing orders to venues with the lowest trading costs) have helped to increase price transparency and competition, thereby lowering transaction costs,” it said. “Algorithmic trading and order execution strategies allow risks to be shared faster and among more market participants.”

Still, the occasional scarcity of liquidity in EM markets has special implications for algos. James of JP Morgan states that this can expose the sophistication of an algo. For a market such as euro/dollar, which may be some $300 million deep, the intelligence and efficiency of an algo may not be as important as in an EM market. “If you’ve got a market that is maybe, 5, 10, 15 deep, with quite a significantly wide spread, the intelligence of the algorithm really gets exposed,” he says.

“Emerging markets have generally lagged with development around the movement of transactions into electronic means of execution”

Usage of algos is not only a case of buy-side participants from developed markets trading EM currencies, but also of EM participants trading their own currencies.

“I think you probably need to look at the type of client and also the behavioural trends associated with them as much as where they’re located regionally. We have certain clients in Asia who do use our algos and use them quite extensively,” James said. At the same time, volume during Asian hours is much smaller than during the European or North American time zones.

“I think the use of those algorithms and the ability to save the spread in emerging markets is definitely a growing theme and we’re seeing that in Asia. We find that clients there don’t use our algos primarily for G10, but do use our algos for some of our less liquid currency pairs,” he added.


Tim Hutchinson, head of eFX at Standard Bank, South Africa’s largest bank, said the question of algo usage in emerging markets starts with the degree of e-trading that takes place. “Emerging markets have generally lagged with development around the movement of transactions into electronic means of execution anyway,” he says. “That’s the starting point.”

Hutchinson said that in South Africa, many clients do a lot of their smaller transactions electronically, but prefer to phone through for a big deal. “To put it in context, a lot of clients are phoning through for deals of about three million dollars to five million dollars or ten million dollars.

Obviously we do have from time to time transactions bigger than that, but particularly in the market we serve, there’s still that kind of dynamic where guys will do anything less than the general million-dollar transactions electronically.”

“The challenge when you start going to algorithmic execution is that all of that risk is then effectively passed on to the client,” Hutchinson said. “Yes, it might be sliced and diced through the market but if the liquidity’s not there, your algo’s not going to be hedging with ultimate payoff for you and you might not get done at all over a certain period of time.”

In terms of how different sectors view algos from within an emerging market country, Hutchinson said institutional money, due to prudential responsibilities, tends to want to pay for the bank to take on the risk. But some commodity clients may be happier to work transactions through the markets.

Another issue for sell-side participants within emerging market countries is latency. Hutchinson said the situation has improved in South Africa in the past couple of years, but minimising latency remains a broad challenge. The good news on that front is that the costs of addressing latency have been declining.

While EM currencies do not necessarily trade as a bloc, there are clear correlations between some of them.

“I think there are some similarities that we do find between us and other EMCs,” Hutchinson said, citing correlations between the Israeli shekel and the rand or between Turkey and the rand.


While emerging market currencies may be showing a degree of volatility during such times of economic uncertainty, market veterans say that the turmoil is not so severe compared to some previous periods of stress.

Clearly, times of complete dislocation present a problem for all market participants. But to the degree that there will generally be buy-side institutions looking to handle their emerging market exposures, algo execution services offers advantages and savings that may not be available from voice or other forms of e-trading.

James of JP Morgan said that when one considers the internalisation option that some large banks such as his own firm can present, participants can benefit from an additional pool of liquidity as well. He concludes by saying that, “I think algos in EM are incredibly important and I would argue that in some cases – obviously not all – illiquid markets are really where algos shine.”