How is electronic trading of FX swaps set to further gain traction this year and how can algo execution be a part of this growth?
Technology is a major theme of 2024. With increasing trading volumes, greater involvement from banks of all sizes and further buy-side participation, the FX swaps market continues its volume growth and migration to electronic channels. This is driving further demand for accurate and robust pricing engines, and for more automated end-to-end workflows.
As trading firms look to improve pricing, they are building ever more sophisticated pricing models which increasingly go beyond existing market data, to include yield curves and inferred FX swap points.
We continue to see banks of all sizes moving away from spreadsheet-based or manual pricing and implementing accurate and robust pricing engines. These are required to efficiently price in the rapidly moving electronic FX markets. Pricing FX swaps is complex: the scale of the challenge is demonstrated by market maker banks typically calculating more than 20,000 prices along their forward curves.
Electronic trading of FX swaps, in both client and interbank markets, will lead to more efficient FX markets. This increased electronification will lead to greater velocity of the underlying market and translates into a greater need for speed and lower latency, as the markets react more quickly to events.
The development of electronic FX swaps marketplaces is still at an early stage, so a degree of algo capability is required to participate, whether for passive execution or for liquidity provision.
As continuous liquidity in these marketplaces increases with more participation, we expect well-established approaches to algo execution, common in other instruments, to become increasingly relevant.
This will be a process of evolution, as the development of electronic markets progresses, and any algos will need to constantly adapt to changes in the market structure and liquidity, the availability of data and the range of participants and strategies.
What were the key challenges in the past which may have prevented the use of algos for FX swaps trading?
Algos need high quality data. In the past this was not easily available for FX swaps, as there was no recognised interbank data feed. Traders relied on FX swaps prices published by brokers, which are among the last to update at times of movement, and do not cover relevant points such as central bank dates and liquidity events (month- and year-end) that often have the largest impact.
This is why DIGITEC and 360T created the Swaps Data Feed (SDF), which is based on participating major FX banks’ raw pricing and represents Interbank quality. Today, the SDF has established itself as a reliable data source, used by many banks and FX swaps market participants in their active pricing of currency curves. It enables clients to build fully automated and accurate real-time curves.
Greater price transparency will lead to greater participation and this in turn will help liquidity in matching venues.
Liquidity was also a major factor, especially further out along the forwards curve. The development of traditional algo trading is dependent upon how fast the market evolves and continuous liquidity is built further out than Overnight or Tomorrow/Next Day. There may be some liquidity seeking algos that will work for FX swaps, but their adoption will be low if there is limited liquidity.
Algos need high quality data and the DIGITEC/360T Swaps Data Feed has established itself as a reliable data source.
Another factor in the adoption of algo trading in FX swaps has been technology – without electronic marketplaces with broad participation, it is difficult to justify the investment in technology needed to support robust and efficient algo trading strategies.
Credit remains an issue and is often referred to as a bottleneck when it comes to further automation in FX swaps and moving towards a more electronic market. Trading in FX swaps is still mostly limited to counterparties with a bilateral credit relationship, therefore, linking liquidity and credit. However, innovation with more dynamic allocation of credit in a market utility type offering and clearing may provide some answers.
How has DIGITEC introduced new innovation into the FX swaps space? To what extent do these provide solutions to pave the way for algo trading in FX swaps?
For FX swaps to automate further, there is a requirement for an efficient and increasingly automated Interdealer FX swaps market, to help firms make markets to clients and efficiently risk manage their positions.
With this in mind, 360T and LSEG offer electronic Interdealer FX swaps trading venues, with other marketplaces looking at establishing additional venues.
At DIGITEC we developed D3 OMS, as a solution for traders to connect directly to these interdealer FX swaps venues. D3 OMS allows the traders to place and manage orders into these marketplaces, with a high degree of workflow automation, so that they are able to scale their business efficiently and can unlock other opportunities for automation within their pricing and risk management processes.
As with any market that is evolving to a more electronic structure, we expect the result to be increased volumes on electronic Interbank matching platforms. This in turn will drive increased market liquidity, greater participation, improved client pricing and risk management, and for the FX swaps market to grow across all execution methods for the benefit of all parties.
What has been the response from banks and the buyside so far? How much of an appetite is there for algo trading in FX swaps and is this from particular segments of the market?
We launched D3 OMS in September last year and are seeing a great deal of interest, some from our existing bank clients and some new relationships which plan to use D3 OMS as a standalone product.
To date we have one bank live and trading on LSEG Forwards Matching, with other banks at different stages of onboarding to both LSEG and 360T SUN.
The typical bank customer that we engage with at this stage already has comprehensive pricing capabilities, and is adding the workflow automation that comes with D3 OMS. We are exploring use-cases with other clients with different requirements, often around risk management automation or efficiently accessing liquidity, and we can bring several elements together for these clients, some of which are likely to involve an algorithmic component.
When do you expect more significant traction in algo use for FX swaps? How do you expect the evolution of e-traded FX swaps to continue and what will be the next steps for its development?
We expect to see more data being integrated from our network of banks, which will further improve SDF data and lead to more accurate market pricing. Greater transparency will lead to better price discovery, which will support the continued automation and electronification of the FX swaps market.
More liquidity in longer dated swaps will be enabled by better data, automated workflows, and more efficient Interdealer markets, so we expect pricing to improve further along the curve in all markets.
Like the rest of the market, the use of execution algos is growing, but in the case of FX swaps is still relatively small. In terms of electronification, FX swaps are still evolving, and are some years behind spot. For algos to gain significant traction there needs to be liquidity across the forward curve (not just the short dates) and pricing engines need to incorporate more data from multiple sources.
