A peek inside GFXC’s algo cover sheets

Order priority and segregation policy among the items under discussion


Plans for new disclosures on foreign exchange trading algorithms are taking shape. The industry body tasked with overseeing currency markets is working on a list of items to include in ‘cover sheets’ that algo providers will be required to publish.

The standardised documents would help users assess different algorithms – a push for greater transparency and comparability in a market that is increasingly crowded and complex.

Under consideration are questions such as how an algo provider prioritises orders in the event of a conflict of interest; whether it routes a trade to its internal liquidity pools or pushes out into the market; and how it ensures its algo trading unit is sufficiently separated from other trading activities.

The work on disclosures is under the direction of the Global Foreign Exchange Committee, made up of regulators and industry practitioners. The GFXC is also running a parallel project to develop guidance on transaction cost analysis (TCA), which evaluates how effective algos are.

A working group within the GFXC is understood to have sent a set of questions to a number of banks that provide trading algorithms, detailing some of the aspects under review.

“The work is based loosely on some of the algo questionnaires that have been in circulation, but nothing has been set in stone yet,” says a person familiar with the discussions.

The GFXC declined to comment on the specifics under discussion.

Algo trading in foreign exchange markets has grown in recent years, with an estimated 10–20% of all FX spot now traded in this way, according to the Bank for International Settlements.

The growth has caught the attention of the official sector. In November, a study produced by 22 central banks warned algo users might not fully understand the risks involved. 

Experts point out algo providers have an interest in not disclosing the inner workings of their robots, for fear of giving away valuable intellectual property. To counter this lack of transparency, regulators are pushing for standardised information on algos.

Better disclosure is one of the main aims of the ongoing three-yearly review of the FX Global Code, the voluntary set of principles for foreign exchange markets. It’s an area where the code can improve, says Guy Debelle, chair of the committee and deputy governor of the Reserve Bank of Australia.

“An aim of the code is to ensure market participants have clear, easily accessible and understandable disclosures regarding trade execution and information handling. This would allow them to make informed decisions about the other market participants with whom they interact,” he says. “Whilst there have been genuine efforts to improve the content of disclosures, there remain a set of key disclosures which can be more clearly and prominently highlighted.”

Wish list

The GFXC has created a series of working groups to handle specific areas of the review of the code. One aspect of algo trading that might come into scope of the working group on disclosures is order priority. Insiders say the GFXC wants to assess how algo providers choose to prioritise orders in the event of a conflict of interest.

“Questions are being asked on what happens if you have two orders coming in at the same time; how does the algo provider manage conflict of interests when they have their own trading needs compared to a client’s trading needs; which comes first?” says a second person familiar with the discussions.

Routing logic is another topic on the radar of the disclosure working group. Questions in this area explore how an order gets routed into the market and on what basis banks choose whether to use their internal liquidity pools or divert the order into the market.

Two areas involving algo safety features could also end up being part of the cover sheets.

The first addresses the level of segregation of the trading unit operating the algos from the rest of a bank’s trading desks. The objective is to highlight the extent to which trading information is compartmentalised within the bank; whether salespeople, for example, are able to see trade orders as they are placed by the algo, and what type of patrol measures are in place.

The second aspect focuses on what measures the algo providers have in place to counteract problems with the algorithm. The cover sheets would aim to clarify how clients are notified; whether they are aware of who owns the risk when something goes wrong; and what alternatives are offered to them should a plan B become necessary.

Closely linked to the safety features is the topic of legal liability. The working group is looking to clarify who is legally responsible in the event of a technical failure. Algo providers say this area is typically covered by the terms of dealing signed by a client – which is then vetted by both organisations’ legal teams. But questions remain on whether the algo users can effectively understand the legal obligations that come with algorithmic trading.

“If an algo breaks down mid-way through an execution due to a technology failure within the bank, and the client then loses out economically on that trade, legally, who is responsible to cover that loss, the client or the bank?” asks the second person familiar with the discussions.

Post-trade reports

The last area under review comprises post-trade practices, including what type of TCA reports algo providers offer to their clients and how they construct their benchmarks to compare algo performances.

“It looks like there is a push to try and see if the post-trade TCA reports could also be standardised in some way,” says a third person familiar with the discussions. “That would not be to restrict the complexity of a TCA report but to insist on a certain number of minimum items that should be included with each one, such as performance versus an implementation shortfall, and inclusive and exclusive of costs.”

FX Markets understands this area is being covered by a separate working group, which could end up creating an annex to the code, detailing what a standard TCA report should look like and what type of information end-users should be getting at a minimum from their algo providers.

Debelle says the work on disclosures will not lead to a change in the wording of the code. The cover sheets, and any accompanying guidelines to the code, will aim to help investors make apples-to-apples comparisons between algo providers.

“The cover sheets are aimed to drive greater transparency around key code principles. The cover sheets would not change the code, but they would provide an easily accessible vehicle through which to meet the disclosure expectations already included in the code,” he says. “Consistency in how certain information is disclosed can also help market participants to compare and contrast the different offerings of their counterparties.”

Minutes from the GFXC meeting in September show the working group on disclosures and transparency highlighting the particular challenges market participants face in “accessing and evaluating the large amount of varied disclosure information that was being made available to clients”.

The working group added that disclosure information is often provided in “an inconsistent manner, with varied structures and levels of detail”. The GFXC asked the working group to come up with ways to allow users to more easily access and compare different disclosure documents.

The GFXC intends to launch a public request for feedback on its proposals in April, Debelle says.

The final proposals will be submitted for approval by the GFXC at the June 2021 meeting, when the review of the code is due to be completed.

Editing by Alex Krohn

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