Brokers branch into futures algorithms

Brokers are preparing for a shift of institutional trading of futures away from trading desks and into electronic “algos”, matching a long-running shift in equities.

Investment Technology Group, an agency brokerage, is the latest to branch out into futures algorithms.

Such computerised trading tools have come to dominate trading in equities. But futures trading is still largely conducted via contact with a human broker, in part because institutions are smaller participants in futures and also because futures trade in a smaller number of venues.

That is changing, however. Hedge funds, pensions and mutual funds will trade about 29 per cent of listed futures in 2011, up from 24 per cent in 2009, according to the research firm Tabb Group.

“High equity correlations and interest rate fluctuations ... will continue to drive institutional usage of futures upward,” said Matt Simon, analyst at Tabb, in a report published last week. The report said: “After decades of relying on their brokers to determine how futures orders are executed, the buy side is poised to trade futures flow electronically.”

There is also a small but growing dispersion of venues where stock futures trade, which increases the need for algos to seek out the best price or deepest liquidity at any given moment.

According to Tabb, the CME Group traded 93 per cent of stock futures in August, down from 96 per cent in January.

While CME still dominates trading in S&P 500 index futures, Russell 2000 index futures now trade on the IntercontinentalExchange, and the MSCI family of index futures now trade on the nascent NYSE Liffe US exchange.

ITG’s new suite of algos, announced on Monday, will focus on equity derivatives, primarily stock index futures.

“It’s not yet like in equities, but for the first time ever the landscape in futures is less static, and it’s got a bit more complicated to trade them electronically,” said Jamie Selway, head of liquidity management at ITG.

ITG has historically been a large player in equities; Tabb estimates that it is the second-largest provider of equity algos to clients, behind Credit Suisse. However, like other brokerages, ITG has struggled as equity volumes and trading commissions have declined, and instead has sought to expand into other more profitable asset classes.

Mr Selway additionally said that regulatory pushes from the Dodd-Frank reforms, to move more trading of derivatives to hedge risk, from over-the-counter to exchanges, was another factor driving the shift.

Brokerages have announced new algos for other derivatives markets as well. Goldman Sachs in June announced its Delta Hedging tool that automatically makes trades in both equities and options markets.

As they have grown in popularity, algos have also drawn scrutiny from regulators, who worry that market disruptions such as the May 2010 “flash crash” may be worsened by “runaway” trading programmes that either switch off or keep making large trades in thin markets.

Both US stocks and futures regulators have considered adopting checks that would examine algos’ code before they are allowed to be used, as is increasingly the practice in Europe and the UK, though the industry believes this is infeasible.