Foreign exchange execution algorithms bring about better market functioning, but it also comes with new challenges

Execution algorithms (EA), intended to purchase or an amount defined in advance of foreign trade as laid out in user instructions, have been experiencing an increase in use in the midst of a rising decentralized and divided trading scheme as indicated by a report distributed today by the Bank for International Settlements (BIS) Markets Committee. This has subsequently aided in upholding pricing and market functioning. However, this also has the possibility of forming new risks, as stated in the report. Furthermore, the report also looks to analyze the drivers and ramifications of the rise in execution algorithm usage in the foreign exchange markets. It draws on a unique survey of 70 refined market partakers from around the world with a large industry wide effort, and providers a particular perspective focused on the use of EAs, also by central banks.

Arranged by a study group and led by Andréa M. Maechler, Member of the Governing Board of the Swiss National Bank, it presumes that although EAs do better the functioning of a market, they likewise also bring about new challenges. More specifically, they pass on execution risk from the sellers to the end customers, adding to changing liquidity dynamics as well as to the fundamental market structure, and increase current standards for market participants in getting to the data, skills and tools needed to get around this market successfully and effectively.

Jacqueline Loh, Deputy Managing Director, Monetary Authority of Singapore, and Chair of the Markets Committee stated, “The report provides an insightful stocktake of the growing use of FX execution algorithms by a broad range of participants in FX markets, and highlights both the benefits and the potential risks of such execution algorithms. This will help market participants gain a deeper understanding of such elements, which are becoming increasingly important in FX markets”.

Moreover, execution algorithms may also form self-enforcing circles and compound sharp price moves, albeit initial perceptions from the Covid-19 pandemic propose that such risks may be less keen than anticipated. All things considered, further research is required.

“While the focus of the report is on the FX market, many of the findings are also of broader relevance to other fast-paced electronic markets experiencing similar trends. As those markets continue to evolve rapidly, access to high-quality data, novel skills and adequate tools becomes key in this context,” said Andréa M. Maechler.

Such issues as these need a large based coordinated effort the official and private sectors. The Global Foreign Exchange Committee (GFXC) has already formed workstreams on algorithmic trading and exposures to inspect them closely in detail.

Source: the BIS