High-Speed Trading Fills Void Left in Proprietary Desks

By John Detrixhe and Sam Mamudi

Wall Street banks struggling with recently defanged currency-trading desks have found a surprising ally: high-frequency traders.
Banks are directly connecting to price feeds from Global Trading Systems LLC and Virtu Financial Inc. to help complete their clients’ currency orders, according to the chief executive officers of both computerized-trading companies. By working with the HFT firms, banks benefit from narrower gaps between buying and selling prices without having to reveal their trades in the wider market or pay fees to use external venues.
“They’ve been partnering with us and other HFTs,” Ari Rubenstein, co-founder and CEO of New York-based GTS, said in a phone interview. “There’s a natural fit here: the banks own the relationships, and we own the cutting-edge technology and the sophisticated algorithms.”
High-speed traders are well known for their role in
the equity market, but this is the first time the heads of some of the industry’s biggest firms have revealed their alliance with banks in foreign exchange. Regulations imposed in the aftermath of the financial crisis restricted banks’ ability to deal currencies on their own account, a practice known as proprietary -- or prop -- trading. That opened the door to co-operation with the HFT firms they once avoided.

Looking Elsewhere

Companies such as GTS and Virtu are helping banks’ currency desks by providing them with an additional source of prices to quote to their customers. Banks always seek to match foreign-exchange transactions internally, although they will also use external price sources. Computerized traders are just the latest price source in a list that includes interdealer brokers and electronic platforms.
An increasing number of banks have asked to receive GTS’s currency feed over the past two years, according to Rubenstein. Meanwhile, profit from trading currencies has climbed faster than it has from stocks at Virtu. Earnings from foreign exchange surged 66 percent between 2011 and 2013, while the equities business grew just 6.4 percent, the company said in a filing last March.

‘Toxic Flow’

Wall Street’s behemoths and the tiny yet technologically adept HFT firms haven’t always been allies in the currency market. The presence of high-speed traders may have been the reason banks withdrew from ICAP Plc’s EBS foreign-exchange platform in early 2013, consultancy Aite Group LLC said in a report in July that year.
“They labeled that algorithmic flow toxic and shunned it,” Javier Paz, a senior analyst at Aite, said in a phone interview. “That’s come full circle. Now both parties recognize that they’re at more or less equal levels of sophistication. They look at them in a more pragmatic way as potential partners.”

Partners Now

Most of the major banks are partnering with HFT firms, according to senior members of the industry, who asked to speak anonymously because they didn’t want to talk publicly about clients and competitors.
Citigroup Inc., Deutsche Bank AG and Barclays Plc -- the world’s three biggest foreign-exchange dealers -- declined to comment.
“The marketplace -- the end users -- are demanding tight pricing,” Doug Cifu, Virtu’s CEO, said in an interview. “Technologically enabled liquidity providers like Virtu can be a real value-add partner to large institutions.”
The tie-ups are a boost to the $5.3 trillion-a-day foreign-exchange market, which has suffered a rate-fixing scandal, last year’s record-low volatility and a thicket of regulations intended to prevent a repeat of the financial crisis. The Volcker Rule limits prop trading in the U.S., while the Basel Committee has made banks hold more capital, making it harder for them to take on risk.
The currency market is considered opaque partly because dealers aren’t required to give their customers the best available prices. In fact, they can offer different prices for the same trade depending on a customer’s credit quality, sophistication or relationship with the bank.
To establish trust with the electronic market-makers, banks sometimes get to know them through a third-party platform that identifies both parties to a trade, Cifu said. State Street Corp.’s Currenex and ICAP’s EBS Direct both fulfill this function. The traditional interdealer market is anonymous.
“A lot of dogma around HFT, I think we’re beyond that in the FX market,” Cifu said.