HSBC FX Algos. Together we thrive. HSBC Implementation Shortfall algorithm
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1 HSBC FX Algos HSBC Implementation Shortfall algorithm For Professional Clients, Institutional Customers and Eligible Counterparties Together we thrive
2 2 HSBC Implementation Shortfall algorithm HSBC Implementation Shortfall algorithm 3 HSBC FX Implementation Shortfall Algorithm description What is the objective of the HSBC FX IS Algorithm? How is it achieved? The HSBC FX Implementation Shortfall (IS) Algorithm aims to eecute an order minimising slippage from the primary market mid price at order Start Time with consideration of the level of market volatility risk tolerance. To achieve its objective, the Algorithm manages the trade-off between market volatility risk and market impact. It optimises the number of child orders to place across HSBC s unique network of FX Liquidity Pools, their size and the time interval between them. The Algorithm also balances the opportunity cost between placing passive orders or crossing the spread by using proprietary fill probability and market impact models. How are market impact and market volatility risk quantified? Time and size-dependent market impact is calibrated on the basis of historical market response to HSBC orders. Market volatility risk is assessed using HSBC s proprietary real-time volatility model. Cost Aggressive Neutral Passive Market Impact Time
3 4 HSBC Implementation Shortfall algorithm HSBC Implementation Shortfall algorithm 5 When/why use the HSBC FX IS Algorithm? Client parameter input When should the IS Algorithm be used? The IS Algorithm should be used when the objective is to What are the input parameters for an IS Algorithm order? When placing an IS Algorithm order with HSBC, the client has to specify the Fraction of Order Amount Eecuted Average Trajectory Eample Eecution Trajectories minimise slippage from the arrival or decision price (i.e. the primary market mid price at eecution Start Time) whilst managing the market volatility risk. Does the IS Algorithm follow a pre-defined schedule? The IS Algorithm does not aim to follow any pre-defined eecution schedule and can therefore finish at any time before the user-defined End Time. The Algorithm s decision-making is based on the result of an internal optimisation (dynamic programming) procedure. A higher trading rate is typically epected at the beginning of the eecution, gradually slowing down towards the end. Larger trades at the very start of the following parameters: Instrument Spot/Forward Value Date Currency Pair Start time Direction Trade direction (Buy/Sell Currency). End time Order Notional Total quantity to trade in Currency. 0 00:00 00:01 00:02 00:03 00:04 00:05 00:06 Eecution Time, min eecution are also common. Eamples of eecution trajectories (100M EURUSD over 15 minutes with a Neutral Eecution Style) are shown on the right (the average is computed over 104 simulated trajectories produced by HSBC s proprietary FX Simulator which makes use of historical market data on a Instrument value date, defaults to the Spot value date of the selected Pair. Eecution of the order commences immediately by default but can be postponed until this time. Eecution 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. production codebase). Is there an advantage in using the IS Algorithm in Limit price Eecution Style Liquidity Pool comparison with the HSBC Risk Transfer Price for instantaneous eecution? On average, the HSBC FX IS Algorithm is epected 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. eecution) risk eposure, and not all 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 net page for details). There is a choice to either use market liquidity, HSBC liquidity or both. Market liquidity sources are detailed in the Appendi. For client algorithmic eecution, HSBC liquidity consists of top-tier streaming for aggressive matching and Internal Echange for both passive and aggressive matching. eecutions will necessarily be better. Clients may not have the risk appetite to use an Algorithm and own the eecution risk, instead preferring to have certainty of price and therefore opting for a Risk Transfer. For which FX instruments can an IS 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 eecuted price on an a posteriori basis. For which currency pairs can an IS Algorithm order be placed? Refer to the Appendi 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 HSBC Implementation Shortfall algorithm HSBC Implementation Shortfall algorithm 7 Measuring Performance and TCA What s the difference between different eecution styles? The selected Eecution Style serves to indicate to the Algorithm When does the Algorithm operate aggressively regardless of the choice of Eecution Style? How is the performance of the Algorithm measured? The IS Algorithm s natural benchmark is the primary market the client s level of market volatility risk aversion. More specifically, The IS Algorithm may decide to trade aggressively after mid price at the start of the eecution (arrival). Other relevant it determines the level of risk aversion or the weighting of volatility comparing the cost of various eecution pathways and benchmarks include the HSBC Risk Transfer Price at the start Eecution Cost, bps risk in the cost optimisation (which is internally translated into an eecution urgency parameter controlled by the Algorithm s configuration) as follows: When the Passive Style is selected, the Algorithm will tolerate market volatility risk and will try to reduce cost by placing passive orders concluding that the fill probability of passive orders it too low and the risk of waiting is too high. It will also place an aggressive order if the remaining order size becomes less than the minimum size eecutable on eternal venues, in which case the remainder is eecuted 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 eample EURCAD of the eecution, the time-weighted average primary market mid price during the eecution (TWAP) and the primary market mid price at the end of the eecution (last eec). A detailed in-house Transaction Cost Analysis (TCA) report displaying these benchmarks is automatically sent to the client following completion of the eecution. more often. It will take longer to eecute. order traded via EURUSD and USDCAD). Indeed, the eistence What other information is provided in the TCA report? When the Neutral Style is selected, the of a maimum leg imbalance (in terms of cumulative eecuted volume) threshold will ensure that the Algorithm closes any such In addition to the previously specified suite of benchmarks, the TCA report presents the realised eecution trajectory Algorithm will be moderately risk-averse with imbalance between the two legs via aggressive eecution. (cumulative eecuted volume versus time) followed by the perceived risk aversion being balanced by Algorithm in conjunction with its child fills and primary Urgency The figure on the above specifically illustrates how the eecution risk is reduced whilst the eecution cost increases with increasing urgency (the results are computed by averaging over 104 simulated eecutions of 100M EURUSD generated by HSBC s proprietary FX Simulator). epected eecution cost savings. When the Aggressive Style iselected, the Algorithm will be highly risk-averse and will try to eecute faster, thus crossing the spread more often whilst minimising market impact. market price action of the currency pair during the eecution. An ehaustive breakdown of child fills by venue, dealer role (maker or taker) along with millisecond-precision timestamps associated with each fill are also visualisable. What is the primary market associated with a currency pair? The primary market is defined as the firm venue where the How can the parameters be set to reflect one s view of the market? 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 The HSBC FX IS Algorithm can be controlled by the Limit all other directly traded pairs, the primary market is Thomson Price, the Eecution Style and the End Time. In particular, if the Reuters Matching (MAPI). For non-directly traded crosses, market is epected to move away, an Aggressive Style would primary market values are synthetically constructed via the be preferable as it results in a faster eecution due to higher risk directly traded legs, e.g. a ZARJPY primary mid price is obtained aversion. On the contrary, if the price is epected to improve, a via the prevailing USDZAR and USDJPY mid prices on MAPI Passive Style of eecution would be preferable as it reduces the and EBS respectively. All benchmark values are based on data weighting of the volatility risk and thus allows more orders to be (including traded volume) provided by these two venues. placed passively. 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 eecution, the Algorithm will still try to eecute 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 eplicitly 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).
5 8 HSBC Implementation Shortfall algorithm HSBC Implementation Shortfall algorithm 9 Order rejection, cancellation, amendment Is it possible to leave an order for any amount? When on-boarding a client, a maimum 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 eecution 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 eecution 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 Eecution Style. Once the amendment is submitted, the eecution will continue as if a new IS 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 eecuted 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 eposed 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 Eecution Style Modifiable
6 10 HSBC Implementation Shortfall algorithm HSBC Implementation Shortfall algorithm 11 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 IS 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 eecution 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. Does the Algorithm use internal and eternal liquidity? If the client selects both internal and market liquidity, the Algorithm will place passive orders in the market and also submit OCO (One-Cancels-the-Other) orders to HSBC s Internal Echange at the same price. Whenever the Algorithm decides to aggress, it will compare internal and eternal prices and liquidity and eecute wherever the conditions are better for the client. Internal liquidity is treated as any other eternal source of liquidity. The platform housing the Algorithm also has circuit breakers that will automatically switch the eecution off if the Algorithm tries to submit too many orders and/or too much volume in a short period of time Internal liquidity is treated as any other eternal source of liquidity. 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 IS 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 eecution venues are determined on the basis of a wide variety of factors, namely best observable price, available liquidity, child fill certainty and likely post-eecution impact. Some factors used in the routing process are not directly observable and are estimates based on historical analysis of past eecutions and market conditions.
7 12 HSBC Implementation Shortfall algorithm HSBC Implementation Shortfall algorithm 13 What are the advantages of using the HSBC FX IS Algorithm? What are the risks of using the HSBC FX IS Algorithm? 1. The HSBC FX IS Algorithm provides access to HSBC liquidity and to market liquidity under HSBC credit rating. It is a 3 rd 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. Eecution Algorithms are usually classified as 1st, 2nd or 3rd generation as follows: a. 1 st generation Algorithms operate under statically predefined schema, e.g. trade 10m during the first second, then every 10 seconds reducing the trade amount by 1m each time. b. 2 nd generation Algorithms introduce some optionality in how the eecution progresses, such as randomising quantity and time between child orders, although the driving rules are still statically configured. c. 3 rd generation Algorithms employ statistical models to drive their decision-making process and react to realtime signals capturing market conditions. 2. The HSBC FX IS Algorithm adapts to market conditions by using probabilistic models. That s our intellectual property. In particular, the models and signals: The eecution risk associated with the use of this Algorithm resides with the client, not HSBC. When using an IS Algorithm instead of immediate eecution via Risk Transfer, the price of the transaction is only known after the eecution. The market might move considerably during the eecution, 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 eecutions for illiquid currency pairs, there may be market conditions in which HSBC is not able to guarantee the Limit Price on child fills. Eecution 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 falgo@hsbc.com Appendi: HSBC FX IS Algorithm availability 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 maimum 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 IS 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 IS 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 eecute 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 eecution when the spread in the primary market is wider than its typical range. In addition, the Algorithm is constrained to operate within maimum realised market impact and percentage of primary market volume thresholds over the course of the eecution. 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 Echange, EBS, Thomson Reuters Matching (MAPI), Currene, Hotspot, Gain GTX, FXall, ParFX, LMAX, CME Spot HSBC Evolve, Bloomberg, FXall, FX Connect, BID FX, Portware FX, FleTrade, 360T, FIX API HSBC, other options on demand Total quantity to trade in Currency
8 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. Ecept 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, ta 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 intended for the use of clients who are professional clients or institutional customers, 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 Designed and produced by HSBC Global Publishing Services_00000_YYMMDD
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