Electronic execution conduct in the FX Markets

Takeaways from the FX Global Code in the current market conditions with focus on execution conduct in the eFX markets

FX markets have seen large spike in volatility, pricing dislocation, thinning liquidity and further rise of algorithmic & electronic trading volumes to both seek liquidity & also to capitalise on higher bid/ offer spreads.

This comes at a time when Trading desks and supporting Technology functions are having to work remotely or from home, increasing the challenge faced by the markets. In this context, I am looking at the execution conduct principals put firmly in place by the FX Global Code (as well as MiFID II, MAD and MAR) that continue to guide market participant's FX execution conduct in these dislocated markets.

Below is a look at execution conduct in the FX market, with specific focus on aspects of conduct that may be build in the electronic execution systems

Agency or Principal execution

With thin liquidity in major currency pairs, and additionally weakness in EM currency pairs with heavy selling in the first two weeks of March, it is more than ever important that clients are made aware of which side of the firm's services is being used by the client: Agency or Principal execution, with clear TCA & Best Execution reporting in place to show agency fees charged & quality of execution achieved for the client.

Information & knowledge of Client orders must also not be mis/used to trade in favour of the market participant, with clear internal need-to-know policy & system implementation in place on client's regular order flow, as well as orders deemed as material (to impact the market).

Order execution prioritisation

Clients should be made aware of the orders execution prioritisation policy, be it on first come first served (time), or aggregated, or size, or some other basis, so that the client receives a transparent outcome. This prioritisation logic can be build in the execution system stack, with both exception monitoring process & senior manager escalation process build in the execution system.

Ensuring market integrity is not disrupted

Both FX Code of conduct, as well electronic markets (specifically via their respective rulebooks) prohibit these types of disruptive market practices, among others:

• Spoofing: Submitting bid or offer at the top of the order book, with an intent to cancel the order prior to execution
• Layering: Entering multiple orders at multiple pricing tiers, with intent to cancel the orders prior to execution
• Flipping: Submitting of orders for the purpose of turning of the market and there by creating volatility
• Stuffing: Submitting or cancelling orders to overload the CLOB and submitting or cancelling orders to delay other participant's executions
• Wash Trade: Buying and selling same instrument without intending to execute a real trade but giving appearance of trading activity to the market
• Momentum Ignition: Initiating a series of orders with the intent of inducing other participants to trade in the instrument accelerating or extending the price trend in the market.

There is a fine line between a disruptive order and a genuine order, with "intent to consummate a trade" at the heart of it. New execution Algos approval process should usually takes care of this. Quotes, Order Submits, Order Amendments, Order Cancellations and Done Trades data from production Algos and execution systems should be audited to look at tell-tale sign of intent. Machine learning and AI tools can be very effective to shift through large quantities of this data. Finally, there must be alerts, controls and kill switches build into both Algos and electronic execution containers to ensure that these conform to the orderly conduct & not disrupt the markets unintentionally.

Pre-hedging

Pre-hedging should only be done, with consent, on principal executions, and never on agency flow. If client orders are pre-hedged before the fill, the pre-hedging policy must be agreed with the client.

Decision to and size of pre-hedging should taken into account market liquidity and size of the order, so that the pre-hedge does not move the market against the client. This can be again be build into the execution system stack, with both exception monitoring process & senior manager escalation process build in the execution system. Again a well build TCA & Best Execution reporting logic should differentiate impact to the market from both pre-headging as well as the order execution.

Last Look

On the ECN/ Request for Streams (RFS/Q) quotes, during the last look window, pre-hedging policy should be agreed with the market, and the policy ideally disclosed publicly. On these ECN orders, hold times must be appropriate and rejections, based on policy, should ideally be Symmetrical, meaning order rejects due to major market movements should at times be both in favour of the market participant and in other times be in favour the client.

Other considerations

There are various other execution considerations that Prime Brokers & Prime of Prime Brokers need to consider. Additionally post-execution, timely matching and resolution of mismatches (& tri-party giveups) are an immediate concern right after the trade is done.

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