Historically, use of algos have been led by traditional fund managers, but hedge funds looking for passive execution and corporates have increasingly been using them, said John Quayle, head of FX algo execution at the UK-headquartered bank. Corporates have generally been more interested in RFQs or the risk transfer price, but seeing they will, on average, get a better fill with an algo is bringing them around, he noted. Similarly, hedge funds have moved from simply wanting to get a trade done, with little interest in taking market risk, to using passive algos.
Still, FX algo uptake remains dominated by the big buy-side like pensions, insurance and asset management funds, Quayle noted. The demand trend across clients is to minimize market impact, he said.
For this, NatWest Markets’ clients use the Client Order Matching System, or COMS, to execute in a liquidity pool comprising internal desks and client flow. “That’s leveraging our client base across corporates and financial institutions who are crossing the spread,” Quayle explained. When an algo is initiated it will place orders, mostly passively, in the COMS liquidity pool. “It then becomes part of our two-way price shown to our client base only. So, when one of our clients crosses the spread, the algo gets to fill the order,” he added. This also allows NatWest Markets to keep the algos simple: “We don’t have to place at external venues and that means we don’t have the complexities of doing so.”
The challenge, however, is keeping the liquidity pool clean, and one of the ways the bank does this is by not showing algo orders to any client where they detect undue market impact. For its more sophisticated applications of technology, NatWest Markets focuses on monitoring the market impact of activity rather than building “ultra-complex” algos, Quayle said. There’s also an initiative to make algos more flexible, so clients can switch between various modes. And though the most common mode is passive using the liquidity pool, sometimes clients want to be more aggressive and sweep the markets. “The changes we are making will allow users to switch more easily from one mode to another without having to stop one algo and start another,” said Quayle. “It’s really about ease of use, keeping the transparency from the client’s perspective whilst giving them the flexibility to decide how best to complete an FX trade.”