Algo wheel adoption picks up in derivatives

Hedge funds are increasingly looking to design “algo wheels” as the best execution tool for derivatives, according to an expert at global fintech firm TradingScreen.

Chris Hollands, head of European and North American sales and account management at TradingScreen, said the firm has been working with London-based hedge funds to develop their own algo wheels for derivatives trading.

“In the equities world, the algo wheel has been prevalent for a couple of years as best execution tool, but now we are seeing some buy-side adoption of algo wheels for futures as well.

“We have witnessed a few large hedge funds in London that have been building their own dynamic interfaces to change the weightings of their algo wheels on a daily or even an intra-day basis,” he said.

Algo wheels are automated routing tools that links trades to a broker based on specific algorithms.
The algorithmic nature of the tool removes the human decision-making that might lead to bias when selecting a particular dealer/broker. In theory, this should lower execution costs and improve execution quality.

Hollands explained that although the market data has been available for algo wheels in derivatives markets since they became more electronified, increased adoption has come about since the beginning of last year under Mifid II’s reinforced best execution requirements.

A key part of TradingScreen’s plans is to help with best execution by building-out its multi-asset automation tools.

“These tools enable the buy-side trader to build their own custom rules via a wide selection of parameters to automate the routing of orders to brokers, their algo suites and venues according to certain market situations or liquidity conditions,” he said.

Additionally, the firm sees a “major opportunity” in the fixed income space.

“We are seeing a major opportunity in the fixed income space because fixed income hasn’t historically been as electronically traded an asset class as equities or listed derivatives and therefore there hasn’t been as much opportunity for vendors to build these types of execution management system (EMS) tools,” Hollands said.

He explained that the use of order management systems in fixed income markets may not be best suited to handling best execution as they are not necessarily built to handle the streaming of market data and order submissions.

A report published by Liquidnet in May found that the concept of best execution could end up being merely theoretical rather than delivering real value to investors.

A survey of over 100 European buy and sell-side compliance decision-makers by Israel-based regtech firm Cappitech last July found the majority were still struggling to fully comply with Mifid II best execution requirements.

Originally featured on Global Investor