Philippe Bonnefoy, the founder of Eleuthera Capital, explains how his firm has evolved over the years in response to changes in the FX market.
“Over the last 20 or 30 years we’ve evolved massively, starting as discretionary macro traders, then using more and more quant models to manage positions and then finally using the quant models to actually do the trading and become a quant portfolio manager,” he says.
Part of the reason for this, explains Bonnefoy, is that the price behaviour of the FX market has changed significantly as market making has become overwhelming conducted electronically. Even now, he points out, FX trading firms need to be cognisant of these changes and how they’ve impacted liquidity when they screen and look at data to test their models.
Uncertainty about regulations, a lack of trusted custodians and concerns about security are key factors that continue to deter many large financial institutions from trading cryptoassets, says Kevin Beardsley, a managing partner at B2C2.
Amongst these three factors, Beardsley cited the lack of regulatory clarity around cryptoassets as the biggest issue for these firms right now, pointing out that no major bank wants to clash with their regulators for trading in what is, relatively speaking, still a small marketplace.
“The large institutions are all waiting for the regulations to become clear, which is a very rational approach,” he says.
Following the launch of the consolidated tape in September, Dmitri Galinov, CEO of FastMatch, is envisaging a new business model whereby the platform will not charge firms at all for brokerage.
Looking ahead in 2018 Galinov explains that the focus for FastMatch is going to be on expanding its market data business, which he predicts could grow large enough that it will be unnecessary to charge market participants a brokerage fee for trading on the FastMatch platform.
The analogous business model to this, according to Galinov, is Facebook.
Justin Slaughter, a partner at Mercury Strategies, warns that US regulators are examining if they need to take further action around algorithmic trading.
Talking about how the Commodity Futures Trading Commission (CFTC) has not necessarily given up on “Reg AT”, which included a controversial provision that trading firms hand over potentially proprietary source code related to trading to the regulator, Slaughter highlighted broader questions about what data regulators should have access to.
“What should the government do to make sure that we have access in an emergency to critical data but not give it so much access that we’re then in danger of leaking our critical proprietary knowledge?” he says.
LMAX Exchange CEO, David Mercer, explains that some market participants need to take a deeper look at their FX execution in order to improve it.
Discussing the findings of a whitepaper published by LMAX Exchange earlier this year, Mercer says that too often buy side firms only look at fill ratios and spreads to judge their execution quality.
Instead, Mercer advocates using five key metrics provided by each liquidity provider and trading venue being used by that trading firm to judge execution quality.
Micah Green, a partner at Steptoe and Johnson, addresses the future of Swap Execution Facilities (SEFs) now that Christopher Giancarlo is the chairman of the US Commodity Futures Trading Commission.
Green points out that Giancarlo was working in the financial services industry during the initial roll out of Dodd-Frank and the SEF rules that were implemented as a result of this legislation.
“I think it became clear to him, and I think it’s reflected in his white paper on swap execution rules, that the SEF rules that were adopted in a relative rush post-Dodd-Frank missed the mark from his perspective as to what the statute required,” says Green, who adds that CFTC staff are beginning to draft now swap execution rules as a result.
Paul Aston, CEO of Tixall Global Advisors, discusses the feasibility of peer-to-peer FX matching between large buy-side firms.
One of the long-standing problems with the concept of peer-to-peer matching between buy-side firms is that the probability of being able to actually put together complimentary buyers and sellers is very low. For example, the chances of a large asset manager needing to sell a certain amount of a particular currency at the exact same time that an insurance company needs to buy the same amount of that currency are remote.
Aston refers to the need to “get away from the quantum problem of having to know when something is available in time and level”, and suggests that there needs to be some form of “dark mechanism” whereby these buy-side firms can leave an order without it being exposed to the market, in order to make peer-to-peer trading more feasible.
Although Greg Wood, SVP, global industry operations and technology at the Futures Industry Association (FIA), says that technology is increasingly causing FX to trade in smaller sizes, he explains that experience in other asset classes shows that this doesn’t necessarily mean that liquidity is diminishing.
With more trading firms using algorithmic execution tools to slice up large FX orders into smaller amounts to reduce market impact, this could potentially create a cyclical pattern where the amount of small orders going through exacerbates the impact of larger orders, forcing firms to execute in smaller and smaller sizes.
“It is to a degree a vicious circle and to a degree we’ve seen it happen in other asset classes, such as futures and equities,” says Wood.
The structure of the FX market means that transaction cost analysis (TCA) within this asset class is unlikely to look like it does equities for the foreseeable future, according Dan Torrey, global head of FX e-commerce sales at Northern Trust.
TCA is clearly much easier to perform in the equities market because it has a consolidated tape, which provides one uniform data set from which firms can analyse the cost and effectiveness of their execution. This, says Torrey, turned equities TCA into “more of a science that’s very hard to dispute”.
By contrast, he points out that, not only is FX an OTC market without a central tape, but that the reference points for pricing has become more diverse over the past decade.
A number of factors, including the increased need for an audit trail for FX execution and a desire to limit market impact, are driving the adoption of algorithmic execution tools amongst buy side firms, says Petra Wikström, global head of execution and alpha solutions at BNP Paribas.
Although Wikström says that the continuing automation and electronification of the FX market naturally leads to more firms broadly using algos as one of their execution tools, there are other specific factors driving the adoption of algo tools by the buy side.