Some officials at the European Central Bank discussed the risks linked to the increasing popularity of complex computer programs that investors and others use to trade currencies, at an industry meeting held earlier this week.
ECB officials and commercial currencies bankers met at an ECB-hosted contact group July 7, and discussed whether banks' technology can cope with a jump in demand from investors to execute orders algorithmically rather than over the phone, according to a person familiar with the matter. They also discussed whether this change will cause an increase in banks' technology costs.
"Those methods have the beauty of a smoother execution. But there are two issues: is the banks' infrastructure robust enough to cope with the increase in demand? And can the also machine break or misbehave leaving a bug in the software?" the person said. It is the first time in recent meetings that the issue has taken center stage in the discussion. The contact group meets a handful of times every year, four times so far in 2014. Members of the group include executives from a number of large currency dealing banks and several ECB staff members.
Algorithms, or computer programs, shred large deals into smaller pieces and spread them over time to reduce their market impact. That mimics a lot of the work traders in banks do, often at a much more rapid speed, but removes a lot of the risk that traders could try to jack up prices or act against customers' best interests. That is an area that has been in focus since regulators around the world started investigating whether currency benchmarks had been manipulated a year ago.
Companies and investors have grown increasingly fond of algorithms rather than human traders as a way to get deals done since that investigation started. A recent report by consultancy Greenwich Associates found that 11% of market participants are now using algorithms for some portion of their trading, up from 7% in 2012. The consultancy firm projects that global use of algorithmic trading for foreign exchange will increase to 18% of the overall market by the end of 2014, a 68% rise in the year. This compares to just 7% in 2012, Greenwich said.
The outcome of the global currencies benchmarks investigation isn't expected to be made public before 2015, but the Financial Stability Board, which coordinates global financial regulatory efforts, is due to publish a review of foreign exchange benchmarks in the next couple of weeks, a person familiar with the matter said.
The FSB, which was tasked in February to complete an assessment of forex benchmarks, is expected to announce new guidelines to reduce the risk of manipulation for currently used benchmarks over the next two weeks, this person said.
