Northern Trust Unveils Buy-Side FX Algos


Can you teach an existing market a new trick?

Northern Trust thinks so as it is introducing a new algorithmic trading suite of strategies designed to help the buy-side find as much natural liquidity in the foreign exchange markets as it can.

Dan Torrey, Northern Trust

As a recap, the foreign exchange market is a 24 hour a day five day a week trading market that totals approximately $5.3 trillion worth of trading per day, according to the Bank for International Settlements. FX trades usually occur in pairs such as Euro/USD or USD/Yen. Trading in the market has been traditionally dominated by a handful of large banks and ECNs and using more manual means.

But the times are changing, Dan Torrey, Global Head of E-Commerce Sales at Northern Trust told Traders Magazine in an interview. First, traders are requiring more transparency into their trades – both on a mid- and post-trade level. Secondly, fragmentation – like in the equities market – has taken place among the trading destinations. Thirdly, the need for optimal execution (think best ex for equities) is becoming a mandate for the sell-side to deliver.

“The equity markets have taught us a lot about trading and we (FX) are being dragged into the 21st Century,” Torrey said. “The equity markets are 20 years ahead of us but both the sell-side like us, and the buy-side, are learning a lot and moving forward.”

To hear Torrey explain it, the adoption of algorithms in foreign exchange trading runs around 30 percent for traditional buy side clients. In equities, that rate jumps to 60% to 65%.

“And when you take into account the fragmentation in FX, where we have perhaps 10 to 12 banks that provide liquidity and a few ECNs, the need for algos to access liquidity just hasn’t historically been there,” Torrey said. But now there are more ECNs, upwards of 30 banks, non-banks and other sources of liquidity, algos now seem a logical technological progression.

So what kinds of algos are being used?

Given the uniqueness of the forex market, VWAP isn’t really an option. But, Torrey said that TWAP is and that it’s one of the most popular. Northern Trust offers TWAP that is somewhat different than what equities traders use. The goal of TWAP here is to minimize the market impact or not signal to the market that a buy-sider is trying to move a large order.

And then there is also TWAPr -or TWAP Random. This twist on the TWAP algo here allows the user to vary the time interval when the child orders are sent out and to randomize the size of the child orders. Torrey said TWAPr is used for extremely large orders – often more than $1 billion in size.

Northern Trust offers a third strategy dubbed “Iceberg.”  Iceberg shows only part of an order while it keep the balance hidden. Akin to a hidden order, these have historically been used mostly by interbank traders, while many buy-siders haven’t been exposed to this type of algo.

Then there is Peg. Peg works in a passive fashion – utilizing a resting order that remains a certain distance away from the NBBO.

“You’d use Peg when you don’t want to cross the spread during a time series of a trade,” Torrey explained. “This is a less time sensitive approach to trading and is geared towards maximizing cost savings. It’s used by some of our more sophisticated clients.”

And lastly there is COIL. The COIL strategy allows the user to trade with a market that is moving against him.

Torrey said the firm’s FX Algo Suite sources highly competitive pricing through its own “liquidity panel.” The liquidity panel, he explained, aggregates pricing from a list of liquidity providers across the globe, while the execution algorithms allow clients to minimize market impact on large orders and utilize a systematic, rules-based process to offset their FX risk. Northern Trust acts as a quasi-agency execution broker.

“We stand as principal in the OTC market. We have relationships with other large banks and ECNs and aggregate and deal on behalf of the client,” Torrey explained. “We take aggregate the Top of Book (the Best Bid/Best Offer) and achieve an optimal fill for our clients. We’re not capturing the spread here. Spread is captured by the liquidity panel – the fx bank or multi bank ECN.”

And the liquidity panel is dynamic. That is, Northern Trust carefully watches the quality of its panel members and can either remove or add new members based on the quality of their provided executions.

“The real power of the FX Algo Suite lies in Northern Trust’s liquidity panel,” said Timothy Linehan, Senior Partner, Silchester International Investors. “We have seen competitive quotes and narrower spreads without a corresponding increase in counterparty exposure, balance sheet risk or operating complexity for Silchester and its clients.”

Finally, the Algo Suite includes Northern Trust’s transaction reporting system which provides clients with a clear view into how their orders are handled. This post-trade execution analysis, coupled with a transparent and explicit fee, allows clients to gain a more holistic and detailed view of their FX program.

“We measure each of these costs every day to ensure liquidity is good and provide optimal executions,” Torrey said.

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