Although widely used in equity markets, only a few corporates have entered the world of algorithmic trading in their FX hedge programs. But that’s changing, according to a Greenwich Associates report, as their use is growing.
In its report, Greenwich attributed the increase in use to the FX fixing scandal of 2013/2014. “As traders and investors discovered that key benchmark rates had been manipulated by large dealers, they have shifted toward utilizing algorithmic trading and transaction cost analysis (TCA) tools to add transparency and accountability to their trading workflow,” Greenwich wrote.
The increase has also been seen in surveys of both of The NeuGroup’s FX Managers’ Peer Groups. In a pre-meeting survey ahead of the groups’ March summit meeting, 51% of respondents said they either started using algos (13%) or have increased their use (38%) in the last two years.
Why is this so? FX managers say they are increasingly finding them useful, for example, in large, potentially market-moving trades like acquisition settlements and the like. Also, broker/dealers offer very detailed reporting on the algo trades after the fact, which can lessen any fears that banks take advantage of their clients. And usually a spread is negotiated in advance so there are no surprises.
Users and bankers cite efficiency as one of the big reasons for algo use. Algos provide more efficient execution for customers by minimizing transaction costs in two ways. First, algos reduce or eliminate information leakage that can result from poor execution, and second, a trade can be divided into multiple pieces that can be executed over a period of time at the lowest possible spreads available in the market, across both public and private venues (the latter of which companies can’t usually access).
Another benefit is a higher level of transparency. That’s because for just about all algo strategies, the bank provides the full detail of each trade, time-stamping each individual “clip,” and showing the all-in rate achieved benchmarked against the primary market inception price, as well as the market average price over the duration of the execution period.
For these reasons their use should grow, said Greenwich. “[As] best execution standards continue to evolve in the FX market, we should expect to see further TCA and algo enhancements and increasing adoption by foreign exchange market participants,” Greenwich said in its report.