HSBC FX Algos. Together we thrive. HSBC FX Liquidity Seeking (LS) Algorithm
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1 HSBC FX Algos For Professional Clients, Institutional Customers and Eligible Counterparties Together we thrive
2 2 3 HSBC FX LS Algorithm description What is the objective of the HSBC FX LS Algorithm? How is it achieved? The is similar to a floating Iceberg order which aims to execute a client order passively without revealing to the market the client s execution interest. This is achieved by splitting the total Order Size into smaller slices scaled in size to the current market activity and passively placing them through time across HSBC s unique network of FX Liquidity Pools at different price levels, thereby tracking the market until the whole order is executed. Completed or not, the order expires at the specified End Time or at date roll time by default.
3 4 5 When/why use the HSBC FX LS Algorithm? When should the LS Algorithm be used? The LS Algorithm should be used when continuous execution in line with market liquidity and volatility is required in order to reduce information leakage and market impact. Client parameter input What are the input parameters for an LS Algorithm order? When placing an LS Algorithm order with HSBC, the client has to specify the following parameters: How different is the LS Algorithm from standard Peg offerings? Standard Peg Algorithm offerings track certain market price levels for detectable behaviours. The HSBC FX LS Algorithm dynamically tracks fill probability which makes it much more difficult to detect. Additionally, it reduces the adverse selection effect of being passive in the market. A simple Peg offer will always track the market at regular intervals, thus increasing the chances of being filled when least wanted. For example, for a buy order in a falling market, a Peg order will always replace at a certain distance from the current market mid whilst the HSBC FX LS Algorithm will progressively become more passive and reduce opportunity cost. Instrument Currency Pair Direction Order Notional Spot/Forward Trade direction (Buy/Sell Currency). Total quantity to trade in Currency. Value Date Start time End time Is there an advantage in using the LS Algorithm in comparison with the HSBC Risk Transfer Price for instantaneous execution? On average, the HSBC FX LS Algorithm is expected to perform better than the Risk Transfer Price, and it can deal with larger size notionals than often provided via electronic Risk Transfer. However, this statistical improvement comes at a cost of market (i.e. execution) risk exposure, and not all executions will necessarily be better. Clients may not have the risk appetite to use an Algorithm and own the execution risk, instead preferring to have certainty of price and therefore opting for a Risk Transfer. Instrument value date, defaults to the Spot value date of the selected Pair. Execution of the order commences immediately by default but can be postponed until this time. Execution of the order ends by default at date roll time of the selected Pair (typically 5 p.m. EST) but an earlier End Time can be specified. The Algorithm will continue working the order with the aim to complete by the specified End Time. Limit price Execution Style Liquidity Pool The Algorithm will consume liquidity at prices no worse than the Limit Price. Passive, Neutral or Aggressive, depending on the client s level of market volatility risk aversion (see next page for details). There is a choice to either use market liquidity, HSBC liquidity or both. Market liquidity sources are detailed in the Appendix. For client algorithmic execution, HSBC liquidity consists of top-tier streaming for aggressive matching and Internal Exchange for both passive and aggressive matching. For which FX instruments can an LS Algorithm order be placed? An order can be placed for FX Spot or Forward instruments. In the case of a Forward order, the Algorithm operates in the Spot market and Forward points derived from HSBC s Forward Pricing Engine are synthetically applied to the executed price on an a posteriori basis. For which currency pairs can an LS Algorithm order be placed? Refer to the Appendix for a list of supported currencies. The specific currency pairs for which the client can leave an order need to be agreed at on-boarding. In the case where the order is for a cross currency pair, e.g. GBPCAD, the Algorithm will use the GBPUSD and USDCAD liquidity to fill the order. However, when the order is for a cross currency pair for which there is sufficient liquidity in the cross market, e.g. EURJPY, both the legs and the direct cross liquidity will be used depending on market conditions.
4 6 7 What is the difference between the three different Execution Styles? The selected Execution Style serves to indicate to the Algorithm the client s level of market volatility risk aversion via depth (specified in terms of fill probability rather than tick distance) and size of limit order placement as well as sensitivity to instantaneous market volatility. More specifically: The cumulative number of primary trades during the period is also included for comparison purposes. The execution trajectories are based on the output of HSBC s proprietary FX Simulator (which makes use of historical market data on a production codebase). Another simulated scenario (Buy 4B EURUSD) with a Neutral Execution Style is presented below: When the Passive Style is selected, the Algorithm will tolerate market volatility risk and track the market with lower fill probability, or effectively, deeper inside the order book. Slice sizes will be closer to the minimum allowed size and response to market moves will be conservative. Buy 4B - For illustrative purposes When the Neutral Style is selected, the Algorithm will be moderately risk-averse and will place orders with 50% fill probability, which means placing at or close to the passive top of book. Slice sizes will approximately match the primary top-of-book size and the Algorithm will be moderately responsive to market moves. When the Aggressive Style is selected, the Algorithm will be highly risk-averse and place orders in such a way that the expected fill probability is high. This will correspond to placing orders at higher prices when buying and at lower prices when selling. Larger slice sizes will be submitted and the Algorithm will be highly responsive to market moves (will frequently reestimate the analytics). Executed Size Fraction per 30 min Total Executed Size Fraction The difference between the three Execution Styles is illustrated in the figure below, which displays simulated execution trajectories of a Buy 100m EURUSD scenario: :00 07:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 Time Buy For illustrative purposes Cumulative Position, m :30 11:35 11:40 Aggressive 11:45 11:50 11:55 12:00 Time Neutral Passive Paid Given
5 8 9 How can the parameters be set to reflect one s view of the market? The HSBC FX LS Algorithm can be controlled by the Limit Price and the Execution Style. In particular, if the market is expected to move away, an Aggressive Style of execution would be preferable as it tracks the market with a higher fill probability and thus results in a faster execution. On the contrary, if the price is expected to improve, a Passive Style of execution would be preferable as it allows the orders to be placed deeper into the book. Will the Algorithm trade at any price in the market? What if the market moves far away? The optional Limit Price prevents the Algorithm from trading at prices worse than the specified value. If the market price is worse than the Limit Price for a period of time during the execution, the Algorithm will still try to execute the order in full but depending on the amount left to complete and the time remaining, the order might result in a partial fill. If clients do not explicitly enter a Limit Price then the Algorithm will continue trading at any market price and will pause trading only if the market spread is deemed to be too wide (Refer to How does the Algorithm react on big market jumps or a market dislocation event? for more details). Are there cases in which the HSBC FX LS Algorithm operates aggressively? The LS Algorithm will place an aggressive order if the remaining order size becomes less than the minimum size executable on external venues, in which case the remainder is executed using internal liquidity. Another case where the Algorithm might act aggressively is when the order is for a cross that is traded via the direct legs (for example EURCAD order traded via EURUSD and USDCAD). Indeed, the existence of a maximum leg imbalance (in terms of cumulative executed volume) threshold will ensure that the Algorithm closes any such imbalance between the two legs via aggressive execution. How does the Algorithm select passive placement for crosses? The Algorithm continuously measures liquidity of the underlying legs using market information and decides whether to place passive orders for one leg or both. If one leg is regarded as illiquid over the configured time window, passive orders are placed on this leg and not on the liquid leg. The liquid leg is executed aggressively on each fill of the illiquid leg. If both legs have comparable liquidity, passive orders are placed on both legs and an imbalance threshold between legs is imposed within which no aggressive catch-up will take place.
6 10 11 Measuring Performance and TCA How does the Algorithm make sure that the Limit Price is not breached for crosses? The Algorithm operates in a special mode in the zone near the Limit Price for the cross. In this zone, there is a zero imbalance tolerance, i.e. each fill in one leg will result in an immediate aggressive catch-up in the other leg. Passive orders are placed in such a way that the probability of an aggressive catch-up fill in the other leg given visible liquidity is high under normal market conditions. Since this probability can never be equal to one due to latency and potential market dislocation events, individual fills returned on the cross can occasionally breach the Limit Price. Can the HSBC FX LS Algorithm be used to track the primary mid? No, HSBC FX LS does not track a certain price level. The closest option would be to select an Aggressive Execution Style. The reason for not doing so is to reduce information leakage and opportunity cost. How is the performance of the Algorithm measured? The HSBC FX LS Algorithm neither has a single fixed benchmark nor does it guarantee completion. Similar to standard Peg offerings, it does not have a single fixed benchmark specifically targeted via statistical optimisation. However, the HSBC Risk Transfer Price at the start of the execution, the time-weighted average primary market mid price during the execution (TWAP), the primary market mid price at the start of the execution (arrival) and the primary market mid price at the end of the execution (last exec) can all serve as multi-factor benchmarks. A detailed in-house Transaction Cost Analysis (TCA) report displaying these benchmarks is automatically sent to the client following completion of the execution. What is the primary market associated with a currency pair? The primary market is defined as the firm venue where the majority of transactions take place for any given currency pair. The primary market associated with EURUSD, USDJPY, EURJPY, USDCHF, EURCHF, USDCNH and USDRUB is EBS. For all other directly traded pairs, the primary market is Thomson Reuters Matching (MAPI). For non-directly traded crosses, primary market values are synthetically constructed via the directly traded legs, e.g. a ZARJPY primary mid price is obtained via the prevailing USDZAR and USDJPY mid prices on MAPI and EBS respectively. All benchmark values are based on data (including traded volume) provided by these two venues. Can the HSBC FX LS Algorithm be used to track the primary top of book? No, HSBC FX LS does not track a certain price level. The closest option would be to select a Neutral Execution Style. The reason for not doing so is to reduce information leakage and opportunity cost. Can one make sure that child orders do not make top of the book and can the distance from the primary mid be controlled? Yes, it is an option of HSBC s FX Smart Order Router, which can be configured to (i) not place inside the observable spread and to also monitor the position of a child order in the book during its lifetime, with a view to restricting duration inside the spread when the market moves towards the order and (ii) control the time a child order spends within a certain distance from the primary mid before getting cancelled and reallocated. Upon client request, these two Spread Control configurations can be enabled and will result in a slower rate of execution as shown in the table below (Child mark-to-market values are obtained against the prevailing primary mid price at fill time): What other information is provided in the TCA report? In addition to the previously specified suite of benchmarks, the TCA report presents the realised execution trajectory (cumulative executed volume versus time) followed by the Algorithm in conjunction with its child fills and primary market price action of the currency pair during the execution. An exhaustive breakdown of child fills by venue, dealer role (maker or taker) along with millisecond-precision timestamps associated with each fill are also visualisable. Algorithm 100m EURUSD child MTM (bps) 100m EURUSD execution duration (mins) LS Passive LS Passive with Spread Control
7 12 13 Order rejection, cancellation, amendment Is it possible to leave an order for any amount? When on-boarding a client, a maximum amount per order and per period of time will be defined at HSBC s discretion. If the client attempts to send an order for a larger amount it will be rejected. Are there any other reasons why an order can be rejected? An order can be rejected at submission for credit reasons. The Algorithm checks credit availability ahead of execution and might decide to not accept the order on the basis of such information. The order can also be rejected due to technical reasons or because the currency pair requested was not set up for the client to trade at on-boarding. The order can also be rejected for conflict of interest or other reasons at HSBC s discretion. Is it possible to change the parameters once the order has started? The client is able to amend certain parameters during the execution without it being destroyed. More specifically, the client is able to modify the Order Size, the End Time, the Limit Price, the Liquidity Pool as well as the Execution Style. Once the amendment is submitted, the execution will continue as if a new LS order was submitted with the new outstanding quantity and running from the amendment time until the new End Time (if applicable) with the other potentially amended parameters. An amendment with a new Order Size lower than what has already been executed will result in the completion of the order and the amount already filled will be booked to the client. An amendment to an End Time in the past with respect to the current time will be rejected and the order will continue without the amendment being applied. All the parameters are summarised in the table below along with their default values: Client exposed order parameters Is it possible to cancel an order once it has started? It is possible for the client to cancel an order once it has started. If the order has already been partially filled, the amount already filled will be booked to the client after the order cancellation. Parameter Instrument Currency Pair Direction Order Notional Value Date Start Time End Time Limit Price Trigger Price Liquidity Pool Execution Style Modifiable x x x x x
8 14 15 Market dislocation Liquidity sources and routing How does the Algorithm react on big market jumps or a market dislocation event? What are the risks? The HSBC FX LS Algorithm has a number of features that mitigate the risks of trading during a market dislocation event. If wide market spreads or large deviations from an internally maintained and continuously verified market reference price are observed at any point in time on a venue, it will be disabled until conditions return back to being acceptable as determined by HSBC. If the primary venue is disabled, the Algorithm will pause its trading activity. The platform housing the Algorithm also has circuit breakers that will automatically switch the execution off if the Algorithm tries to submit too many orders and/or too much volume in a short period of time. In such situations, the order might not be filled in its entirety and if there is no Limit Price the Algorithm might return a fill rate which is far away from where the market was when the order started. HSBC reserves the right to administer its discretion as to the thresholds and tolerances of these circuit breakers. Internal liquidity is treated as any other external source of liquidity. Does the Algorithm use internal and external liquidity? If only external liquidity is selected, the Algorithm will only use internal liquidity aggressively when the remaining order amount is too small to execute externally (typically below 1 million of base currency) or in the case of a cross currency pair when there is an imbalance beyond a configured threshold between the two currency pair legs used for execution. If both external and internal liquidity options are selected, the Algorithm will place OCO (One-Cancels-the-Other) orders on external venues and HSBC s Internal Exchange at the same price. If only internal liquidity is selected, the Algorithm will only place on the Internal Exchange. Is it possible that client orders may compete with other HSBC orders? HSBC and client orders are treated independently. Since HSBC might be active in the market with its own orders at the same time as an LS order, they may interact in the market and compete for the same liquidity or potentially match. Priority of child orders is strictly time-based. How are routing preferences determined? Routing preferences across different execution venues are determined on the basis of a wide variety of factors, namely best observable price, available liquidity, child fill certainty and likely post-execution impact. Some factors used in the routing process are not directly observable and are estimates based on historical analysis of past executions and market conditions.
9 16 17 What are the advantages of using the HSBC FX LS Algorithm? What are the risks of using the HSBC FX LS Algorithm? 1. The HSBC FX LS Algorithm provides access to internal and market liquidity under HSBC credit rating. It is a 3rd generation Algorithm employing statistical models to drive the decision-making process and reacting to real-time signals capturing market conditions in contrast to earlier generations using statically predefined schema or heuristic rules. Execution Algorithms are usually classified as 1st, 2nd or 3rd generation as follows: a. 1st generation Algorithms operate under statically predefined schema, e.g. follow a single venue bid with 1m. b. 2nd generation Algorithms introduce some optionality to the execution, such as slice sizes being a fraction of available liquidity or following the mid rather than the bid, although the driving rules are still statically configured (this type of Algorithm, often referred to as Peg, is commonly part of standard platform offerings). c. 3rd generation Algorithms employ statistical models to drive their decision-making process and react to real-time signals capturing market conditions. 2. The HSBC FX LS Algorithm adapts to market conditions by using probabilistic models. That s our intellectual property. In particular, the models and signals: a. Determine the choice of venue where to place child orders by looking at historical liquidity, current prices, historical fill ratio and taking into consideration the mechanics of the specific venue (lit venue vs dark pool, firm vs non-firm liquidity), looking for the maximum chance of a fill at minimum cost. b. Optimise fill probability which is the key factor in deciding which price level to place the order and whether to stay passive or cross the spread. c. Help minimise information leakage because size, time, venue and price of an order placement form a dynamic process and not a predetermined scheme which can easily be detected. 3. Like all other HSBC FX Algorithms, the LS Algorithm has a modular structural design embedded within its decision-making process. This allows HSBC to continuously enhance the underlying models and transparently deliver performance improvements to clients. 4. The HSBC FX LS Algorithm has robust safety features to constrain its behaviour in abnormal market conditions. Specifically, the Algorithm is restricted as to the amount of volume it can execute within a given period of time, is restricted in the amount of time it is able to cross the spread in a given period of time, and will pause execution when the spread in the primary market is wider than its typical range. The execution risk associated with the use of this Algorithm resides with the client, not HSBC. When using an LS Algorithm instead of immediate execution via Risk Transfer, the price of the transaction is only known after the execution. The market might move considerably during the execution, which may or may not result in a disadvantageous outcome for the client. If a Limit Price is specified and the market moves considerably, the Algorithm may not achieve full completion. Due to uncertainty of legged executions for illiquid currency pairs, there may be market conditions in which HSBC is not able to guarantee the Limit Price on child fills. Execution will ultimately always be liquidity-dependent, e.g. if the market becomes distressed, the Algorithm may fail to complete the order before the End Time. HSBC may be active in the market with its own orders at the same time as client orders. Although treated independently, they may interact in the market and compete for the same liquidity. For more information, contact your sales representative or fxalgo@hsbc.com Appendix: HSBC FX LS Algorithm availability Instruments Currency Pairs Liquidity Pools Platforms TCA Order Size Spot, Forwards All crosses of USD, EUR, JPY, GBP, CHF, AUD, CAD, NZD, NOK, SEK, DKK, CZK, PLN, HUF, RON, CNH, HKD, SGD, THB, TRY, ILS, ZAR, MXN, RUB HSBC Top-Tier Streaming, HSBC Internal Exchange, EBS, Thomson Reuters Matching (MAPI), Currenex, Hotspot, Gain GTX, FXall, ParFX, LMAX, CME Spot HSBC Evolve, Bloomberg, FXall, FX Connect, BID FX, Portware FX, FlexTrade, 360T, FIX API HSBC, other options on demand Total quantity to trade in Currency
10 Disclaimer This document is issued by HSBC Bank plc and has been produced by a member of the Sales and Trading Department of HSBC Bank Plc and/ or its affiliates, collectively known as ( HSBC ) and not by HSBC s Research Department, and does not constitute investment advice. Investors must make their own determination & investment decisions. HSBC has based this document on information obtained from sources it believes to be reliable but which have not been independently verified. Any charts and graphs included are from publicly available sources or proprietary data. Except in the case of fraudulent misrepresentation, no liability is accepted whatsoever for any direct, indirect or consequential loss arising from the use of this document. HSBC is under no obligation to keep current the information in this document. You are solely responsible for making your own independent appraisal of and investigations into the products, investments and transactions referred to in this document and you should not rely on any information in this document as constituting investment advice. Neither HSBC nor any of its affiliates are responsible for providing you with legal, tax or other specialist advice and you should make your own arrangements in respect of this accordingly. The issuance of and details contained in this document, which is not for public circulation, does not constitute an offer or solicitation for, or advice that you should enter into, the purchase or sale of any security, commodity or other investment product or investment agreement, or any other contract, agreement or structure whatsoever. This document is only intended for the use of clients categorised as Professional Clients or Eligible Counterparties under the rules of the FCA, and is not intended for Retail Clients. This document is intended to be distributed in its entirety. Reproduction of this document, in whole or in part, or disclosure of any of its contents, without prior consent of HSBC or any associate, is prohibited. Unless governing law permits otherwise, you must contact a HSBC Group member in your home jurisdiction if you wish to use HSBC Group services in effecting a transaction in any investment mentioned in this document. HSBC Bank plc Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority Registered in England No Registered Office: 8 Canada Square, London, E14 5HQ, United Kingdom Member HSBC Group September 2018
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