Banks prepare to unleash FX swap bots

At least two dealers are poised to offer execution algorithms for foreign exchange swaps once liquidity on electronic interdealer venues reaches a critical mass.

BNP Paribas and JP Morgan have built execution algos for use by clients, but with electronic interdealer swap venues still in their infancy, the technology currently only accesses the banks’ internal liquidity.

FX swap volumes on platforms have grown but bilateral voice trading remains the preferred execution method.

Asif Razaq, global head of FX algo execution at BNP Paribas, says that once activity on venues such as Refinitiv and 360T increases, the bank will be able to connect its swap algos to them and access a wider liquidity pool.

“Banks have now developed fully automated pricing engines for swaps, as well as risk management engines and hedging algorithms. When you package these together, you are able to make markets in swaps on electronic platforms,” he says.

This will help create a “new ecosystem of electronic liquidity for swaps” on venues such as electronic communication networks (ECNs) and dealer-to-client platforms, Razaq says.

“The minute these electronic swap markets become available, clients can start to utilize execution algos to exclusively trade swaps. This is a big area of growth that we are currently working on,” he adds.

JP Morgan has also deployed a swap algorithm for clients based on the bank’s own internal liquidity. The algo is known as ‘take-profit’ and was launched four years ago.

“JP Morgan has been among the first to develop algo products in the FX swaps space, and we have been quite heavily invested in electronification for a few years,” says Liyan Yu, head of eFX swaps trading at JP Morgan.

Deutsche Bank has previously confirmed it is working on swap algos that could potentially tap into CME’s FX Link platform, which offers FX swap replicas via listed futures.

Estimates of the growth of electronic FX swap trading vary. The Bank for International Settlements 2019 survey reports that half of the FX swaps used for hedging and risk transfer are traded electronically. The Bank of England’s semi-annual FX turnover survey found just over a third of FX swaps were conducted on electronic trading systems or brokering systems in October 2021—a figure that is relatively flat year-on-year.

Buy-side firms and banks have tended to trade bilaterally largely because of the bespoke structures involved in swaps. Tenors can be standard and non-standard – also known as broken dates – and in some instances, both legs can be traded as forwards.

But with spot trading almost fully electronified, many predict that swaps will follow a similar pattern.

An FX algo executive at a large US bank says they are preparing for this shift by transferring skills in electronic trading from the spot business across to the swaps desk.

“There are a lot of products being built by the interbank platforms and ECNs over last number of years, and the electronification story around swaps is accelerating. To continue being a critical market player, we will look to bring e-trading expertise into the voice trading nature of the swaps market,” he says.

Build it and they will come

Venues are creating the infrastructure for electronic FX swaps trading, in anticipation of further growth in volumes.

Firms such as Refinitiv and 360T are working to develop an electronic interbank market for FX swaps. Their platforms offer banks a venue to hedge their risk electronically, especially at the short end of the swaps curve where volumes have seen sharp growth.

For example, 360TGTX MidMatch is a dark pool venue that enables participants to exchange risk at mid-market, using a feed of swap data created in collaboration with software firm Digitec.

“Institutions with substantial swap businesses are seeing large amounts of trades coming to their book and they are now electronically risk-managing parts of this. As a result of venues like ours, it is now possible to hedge this electronically,” says Simon Jones, chief growth officer, 360T.

Elsewhere, both 24 Exchange and Refinitiv reported their first trades on their respective electronic interdealer FX swaps platforms last year. In the dealer-to-client space, CME’s FX Link enables firms to mimic FX swaps by enabling them to trade the basis between an over-the-counter spot and an FX future. The platform recently set a new record for average trading volume.

These platforms are hoping to capitalize on further electronification of FX swaps, as developments in the interdealer market could fuel automated risk management and market-making in the dealer-to-client space.

“Most of the clients’ executions are done electronically, however there’s a sizeable interdealer bank space where a lot of the volume is hedged via voice broker. What we are seeing is more innovation from various platforms that is changing the landscape. It’s still in the early stage, but I think as the interdealer market becomes more electronic, this will improve the price discovery process and the liquidity we can provide to clients,” says JP Morgan’s Yu.

A barrier to the adoption of electronic swaps trading is credit. Assessing the creditworthiness of a buy-side client and the impact the swap trade would have on the bank’s balance sheet is still a manual process.

360T has sought to resolve this by enabling banks to connect to its automated credit model via an API or the bank’s own proprietary credit engine. The platform is also working with other fintech firms such as Cobalt to accommodate banks’ more niche approaches to credit distribution.

360T’s Jones says this will further help the banking industry switch to electronic trading for swaps. “The investment we are seeing by participants across the spectrum suggests that there is an inevitability about the direction the industry is heading,” he adds.

“To my mind at the pace of development we are seeing, I think within 18 months, a big part of the FX swaps market will be hedged electronically.”

Additional reporting by Laura Matthews