Joe Morgan
Joe Morgan

Smart but not fast - how technology is democratizing FX

As the activities of high frequency trading firms fall under increasing regulatory scrutiny on both sides of the Atlantic, the preeminent importance of having the fastest trading kit is arguably receding among FX market participants reports Joe Morgan.

First Published: e-Forex Magazine 75 / Market Commentary / March, 2017

The proliferation of trading technology that encompasses all stages of the FX trading lifecycle and the growing accessibility of big data is opening up FX markets to a wider range of participants. Some say this trend – coupled with the increasing sophistication of trading tools provided by major technology and financial information providers – is having a democratizing effect on global FX markets. The proliferation of this technology is enabling participants to focus on being the smartest – not fastest – when trading global FX.

Neill Penney, co-head of trading at Thomson Reuters in London, says the FX industry has taken decisive action to prevent an “unending low-latency arms race” which is helping to ensure that the market does not become the preserve of just a handful of high-speed participants.

I think technology nowadays is used essentially to ensure consistency and fairness, and to support the movement to what the global conduct committee believes is appropriate conduct for the market. In this sense it is helping to provide a level playing field,” says Penney.

RANDOMIZATION OF ORDERS

ParFX, a subsidiary of the Tradition Group operating a London-based electronic FX trading platform, has introduced randomizing technology within its matching engine that prevents high frequency trading firms from implementing latency arbitrage strategies. When a participant on the platform executes an order to trade it is automatically randomized which has the effect of slowing down trades by between 10 and 30 milliseconds. The randomized matching engine works on similar principles to the speed bumps implemented on IEX Group’s alternative trading platform, featured in Michael Lewis’s controversial book, Flash Boys: A Wall Street Revolt.

“Not knowing exactly and consistently when your order is going to be cancelled has a big impact on low-latency, high frequency arbitrage trading strategies – that’s our first pillar – trying to eradicate poor behaviour driven by latency advantages,” says Roger Rutherford, Chief Operating Officer at ParFX in London.

ParFX is not alone. Thomson Reuters is among a host of platforms to have put in place latency flaws. The global information and technology provider has put in place a randomization mechanism on its spot matching venue, which deliberately adds delays of several milliseconds to messages received from market participants. “The market is now talking more and more about speed bumps,” says Rutherford.

ParFX also implements a flat brokerage fee structure whereby all participants pay a flat two dollar fee on all trades made on the platform. Furthermore, market data is distributed to all market participants at the same time, removing the potential for major trading firms to obtain an unfair advantage over rivals in the market by purchasing highspeed market data.

These measures taken by ParFX to ensure a transparent and equal playing field on its platform are already disrupting the trading strategies of high frequency trading firms.

For example, a major North American high frequency trading firm found that three of its five high-speed trading strategies failed to work on the ParFX platform, according to Rutherford. “By moving to a platform where everyone is treated fairly and equally you are judged upon your trading intelligence rather than your speed,” he says.

EBS Broker Tec, the electronic trading platform, has a randomizer of three to five milliseconds installed on its matching engine to help ensure it operates a trading ecosystem that does not disadvantage less technologically advanced market participants. “You can be one millisecond slower than the next person but your order will end up randomized – probably in the same batch – and you can still compete,” says Tim Cartledge, Global Head of FX at EBS BrokerTec in London.

Roger Rutherford

Roger Rutherford

“By moving to a platform where everyone is treated fairly and equally you are judged upon your trading intelligence rather than your speed,”

A MORE EQUITABLE DATA DISTRIBUTION

EBS has also taken steps to build up a more widespread and loyal client base by improving levels of data distribution across the entire market. The platform’s EBS Live Ultra data feed provides spot FX data at two publication intervals: 5 milliseconds and 20 milliseconds. EBS does not restrict access to its fastest, low-latency data feed. Rather, market participants must meet certain trading criteria in order to obtain access to the low-latency feed. “It is not the fund with the fastest connection that gets the fastest access to data,” explains Cartledge. “It is going to be the fund that actually creates some value for the ecosystem.”

High frequency trading firms that obtain access to the faster data will have to make markets on 40 percent of the total volume traded in order to qualify for the low-latency data. Cartledge points out that market participants on the platform that obtain access to the slower feed will not be disadvantaged because they will have the same view of the order book as all the other firms when making a trade. “Funds with different technological capabilities need not be disadvantaged,” he says. “The entire client base benefits through increased liquidity and more client information.”

Still, Cartledge concedes that a consequence of installing a randomizer on the platform’s matching engine is a reduction in levels of transparency. “If there was absolute transparency – real-time information – people who are faster at processing that information would have an advantage,” he says.

Tim Cartledge

Tim Cartledge

“Funds with different technological capabilities need not be disadvantaged.”

A POST TRADE TECHNOLOGY ADVANCE

Larry Tabb, founder and research chairman of TABB Group, the financial technology research and strategic advisory firm based in New York, points to improvements in post-trade transaction cost analysis (TCA) as contributing in part to a more democratic FX trading landscape. The widening accessibility of tools that enable participants to measure the quality of FX execution is helping investors and compliance officers meet more stringent reporting requirements in the DoddFrank Wall Street Reform and Consumer Protection Act and the Group of 20 financial rules. Tabb says these regulatory requirements – which have put more stringent demands on participants to put better risk analytics in place – has bolstered technological innovation. Investors are now required to obtain access to a variety of data points, including the date of a trade and forward rate, along with an accurate timestamp. “At the core of this is valuation,” says Tabb. “What did I buy and what is it worth? If you trade outside your base currency, FX has a tremendous amount to do with what the value of the assets you hold. So, a lot of the risk management infrastructure revolves around real-time FX valuation.”

THE FULL TRADE LIFECYCLE

Bloomberg LP offers its clients a comprehensive FX platform that encompasses all stages of the trading cycle, from pretrade analysis and execution to post-trade analysis. Tod Van Name, Global Head of FX and Commodities Electronic Trading at Bloomberg in New York, says the accessibility of this technology to a widening client base is democratizing FX markets. The suite of products and services available to Bloomberg clients via its FXGO portal, a multi-bank FX trading platform, is providing new market participants with unprecedented access to levels of liquidity and trading services.

“Large financial firms and hedge funds used to be the ones that had the technology to quickly access liquidity in fast moving markets to get ahead of the market. That is not to say that there aren’t some firms out there that have very fast technology, but I think as a whole the market has improved its reliability and its execution performance.” Van Name says smaller market participants have in the past been at a disadvantage due to the complexities inherent in FX trade processing which far exceeds that of other asset classes such as equities. Bloomberg’s FXGO platform has over the past two years increased its focus on ensuring market participants in peripheral trading centers located far from global hubs such as New York or London obtain access to low-latency, automated trading services across a widening range of product groups, according to Van Name.

“Technology providers and execution platforms have moved well beyond simply providing spot execution,” he says.

Tod Van Name

Tod Van Name

“Technology providers and execution platforms have moved well beyond simply providing spot execution”

Van Name says a variety of products ranging from forwards, swaps and deposits are now “abundantly available” to smaller FX market participants. For example, the Bloomberg FXGO portal in December 2016 began providing its clients with executable streaming for nondeliverable forwards (NDFs), with the aim of facilitating better – and faster – pricing for its clients. Standard Chartered Bank became the first to participate on the platform, providing streaming rates for NDFs on the Bloomberg terminal.

Van Name says the focus is now “really much more about the workflow - from netting, aggregation and allocations, through staging and a variety of execution methods all the way down to STP and the matching and settlement. It used to be that all those things were done on disparate platforms that didn’t connect or talk to each other, and now you can find providers – like Bloomberg – where you can do all of that in one place. So it has not only reduced operational risk. It enhances performance and efficiency and that is a really big issue these days. How do you become more profitable when markets aren’t moving? How do you cut costs?”

BIG DATA IN FX

Penney says market participants can now reap the benefits of the capacity of global financial information providers such as Thomson Reuters to number crunch huge volumes of data. For example, when a key US jobs report is published, Thomson Reuters utilizes the depth and breadth of the data it holds to provide its clients with the market consensus and analytics needed to obtain a speedy and transparent snapshot of prices after a spike in trading activity. “Thomson Reuters data has I think the largest number of subscribers in the world following euro/dollar in real time,” says Penney. “I think a good example of using technology is our harnessing the power of big data to crunch all of that quickly, helping to establish more transparency for the market.”

Penney says the suite of market data services available on Thomson Reuters’s electronic platform FXall is a good example of how technology is facilitating a more equitable FX trading landscape. “The use of big data enables a wider range of market inputs to be processed and distributed to all to provide a cleaner picture of the market without compromising confidentiality and without market participants having to make that investment themselves,” says Penney.

Van Name says that “The use of big data enables a wider range of market inputs to be processed and distributed to all to provide a cleaner picture of the market without compromising confidentiality and without market participants making that investment themselves. We can now look at trades that have transpired and see if there has been an increase in people selling dollar yen options or an increase in Brazilian NDF contracts. So it may not be real time as yet. But there is certainly a lot of information out there that gives a much wider audience in terms of what is happening in the market place.”

Neill Penney

Neill Penney

“Solving deep problems that customers have - such as how to achieve best execution - helps you earn the loyalty of your clients.”

He also states that, “The result of greater transparency via trade repositories means we can now look at reported trades and see if there has been an increase in people selling dollar yen options or an increase in Brazilian NDF contracts. It may not be real time as yet, but there is certainly a lot more information available that benefits a much wider audience in terms of what is happening in the market place.”

The Thomson Reuters platform offers users a variety of posttrade and best execution analytical tools that enables a wide pool of clients to refine trading strategies and meet increasingly stringent trade reporting requirements internal auditors, external clients and stakeholders. For example, Thomson Reuters in December 2016 announced a partnership with BestX to enable its buy side clients using FXall to achieve and demonstrate best execution. Under the initiative, clients of Thomson Reuters will be able to have their trades automatically directed to BestX for independent post-trade transaction cost analysis.

“This is a big area of investment for us,” says Penney. “Solving deep problems that customers have - such as how to achieve best execution - helps you earn the loyalty of your clients. The next time they have a problem they come back to you and ask if you have a solution.”

SPEED STILL KILLS

Still, Tabb argues that the lowlatency arms race is far from over with speed remaining of pre-eminent importance in FX trading. He points to the £244 million transatlantic cable installed by Hibernia Networks, providing paying subscribers with a 59.5 millisecond roundtrip time across the Atlantic Ocean. Heavy investment in microwave towers across Europe – built to shave milliseconds off the execution time of trades – has still not abated, notes Tabb.

Larry Tabb

Larry Tabb

“While they can slow down the market as much as they want, increasingly, the buy side is using more algorithms and algorithms are going to the markets that provide the best price.”

Tabb says major high-speed trading firms such as Chicagobased Citadel LLC, Amsterdambased Flow Traders, New York-based Hudson River Trading and Virtu Financial are playing an increasingly important role making markets in FX. “While they can slow down the market as much as they want, increasingly, the buy side is using more algorithms and algorithms are going to the markets that provide the best price,” says Tabb. “This will basically be high frequency markets. At least that is how it has played out in many other highly liquid markets.”

Still, David Mercer, Chief Executive Officer of LMAX Exchange, an FCA regulated MTF (Multilateral Trading Facility) for FX trading based in London, highlights the efficiencies and cost benefits that high frequency trading firms have brought to the FX market. “The cost of trading in any asset class has never been lower than it is today,” says Mercer. “While we hear talk about the dark arts of high frequency trading I think it is inarguable that they have benefited the market.”

David Mercer

David Mercer

“Smarter more open technology creates a fairer market place. On this basis technology aids democratization in the FX market place.”

THE NEW FX TRADING LANDSCAPE

Penney of Thomson Reuters views the increasingly powerful position of high frequency trading firms as the imprint of an evolving market structure rather than evidence of an unfair and undemocratic FX landscape. He points to stringent capital requirements in regulations such as MiFID II as having a prohibitive impact on major sell side performing their traditional role as market makers, enabling firms such as Citadel and Virtu to step into the fold.

“Most market participants in foreign exchange are looking for a robust, fair and transparent market,” says Penney. “What we are seeing is one separate part of the market – which is market-making – being separated from the banks for conduct and capital reasons, and it is becoming more about technology. I wouldn’t let this one feature of the landscape distort the overall picture about what the market is looking for and prioritizing in FX trading.”

The proliferation of increasingly sophisticated trading technology across all stages of the FX lifecycle has enabled a wider pool of participants to trade more intelligently. “Smarter more open technology creates a fairer market place,” says Mercer of LMAX Exchange. “On this basis technology aids democratization in the FX market place. That’s for sure. But we have a long, long way to go. The FX market I believe is maybe ten years behind more developed markets operating on central order books such as equities and futures.” Meanwhile, while an evolution in FX market structure has placed big high frequency trading firms at the fulcrum of market making the introduction of technologies such as randomizers are preventing less technologically advanced participants from being disadvantaged. Being the smartest – and not the fastest – is arguably becoming the prime mover in FX.