Instinet-FIS deal highlights need for algorithmic trading partnerships

Instinet-FIS PoV pic

The announcement by Instinet that it has agreed to acquire the FIS Execution Services business (formerly known as ‘Fox River’) from FIS highlights the need for banks and brokers to partner with FinTech specialists to modernize, customize and expand their algorithmic trading capabilities. In the Chartis Research Algorithmic Trading Solutions, 2022 report, analyst Michael Mollemans maps out the global algorithmic trading commission trends across multiple assets and makes the case that banks and brokers must form more partnerships with FinTech specialists to leapfrog the intensifying competition in innovation and deliver improved execution performance outcomes for clients.

Demand for multi-asset algorithms continues to grow

We believe that the MiFID II initiative, in 2018, to unbundle research from trading commissions, as well as growing demand for automation, has led to a rapid increase in the use of execution algorithms is the past few years. Based on interviews with algorithmic trading solution vendors and buy-side traders, we estimate that algorithmic trading services’ share of the global equity trading commission wallet grew from about 30% in 2018 to 66% in 2022, while high-touch trading services and portfolio trading services make up the remaining 34% share of trading commissions (see Figure 1).

Figure 1: Algorithm, portfolio, and high-touch equity trading commission wallet share

Instinet-FIS PoV pic 1

Source: Chartis Research estimates based on interviews with algorithmic trading vendors

Demand for algorithmic trading solutions is expected to grow this year and next, with trading volumes and volatility levels remaining high as several causes of uncertainty persist, including the COVID-19 pandemic, Russia’s invasion of Ukraine and multiple interest rate hikes on the horizon. According to our interviews with vendors of algorithmic trading solutions and buy-side traders, we estimate that global equity algorithmic trading commissions will grow 8% year on year in 2022 to $19 billion (see Figure 2), with 43% coming from the Americas, 30% from Europe, the Middle East and Africa (EMEA) and 27% from Asia-Pacific.

We also estimate that algorithmic trading commission growth rates for forex, futures, options, fixed income, and crypto will be higher than for equity in the coming years. In 2023, we estimate that the global algorithmic trading commission wallet of $34 billion will be broken down as follows: equity (59%), forex/crypto (19%), futures (12%), options (6%) and fixed income (4%).

Figure 2: Commission estimate for global multi-asset algo trading solutions

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Source: Chartis Research estimates based on interviews with algorithmic trading vendors

Growing need for algorithm provider partnerships

As the latest and greatest algorithmic trading solutions innovation increasingly comes from nimble FinTech specialists that are not shackled to a legacy technology stack, banks and brokers must do more to partner with FinTech innovators. JPMorgan Chase CEO Jamie Dimon has correctly pointed out that FinTech is an ‘enormous competitive threat’ to banks and their ‘inflexible legacy systems’.

Historically, FinTech algorithm specialists were referred to as ‘white-label’ providers but that terminology is out of date. These specialists are now referred to as ‘partner-label’ providers. And algorithm innovation in fixed-income and crypto trading is increasingly coming from trading platform providers. Based on our interviews with algorithmic trading solution providers and buy-side traders, we estimate that bank and prime broker (B/PB) algorithm providers have a 71% share of the global equity algo commission wallet, with non-B/PB executing brokers, partner-providers and platform-providers taking the remaining 29% share.

Staying ahead of the technology curve

The algorithmic trading solutions industry can be traced back to 1990, when Jefferies’ Investment Technology Group (ITG) launched the first electronic equity trade management system. In 2000, Credit Suisse’s Advanced Execution Services (AES) group launched an expanded ‘suite’ of algorithms that were made available to clients through most execution order management systems (EMSs) using FIX as the primary communications protocol. In 2003, Pragma Trading became the first independent technology firm to launch an algorithm suite that was sold to both sell-side brokers and buy-side hedge funds.

Since then, algorithmic trading infrastructures have progressed across three distinct generations in the past decades. First-generation algorithm technology was most commonly applied during the first decade of development from 1995 to 2005, although it is still being used by some brokers today. Second-generation infrastructures were characterized by the move to low-latency order routing. Third-generation infrastructures are characterized by increased investment in cloud services.

Chartis believes that providers of algorithmic trading solutions are not differentiated by their investment in switches and routers infrastructure, but rather by their ability to leapfrog the competition and deliver innovative techniques designed to deliver performance alpha for their clients. Differentiation can come from several elements, such as employing the latest innovative techniques or intellectual property, leveraging a firm’s own proprietary internal data, harnessing and accessing a firm’s own unique natural liquidity, or access to market-maker liquidity or systematic internalizers. We believe that algo providers that embrace change through FinTech technology partnerships will be better able to stay ahead of the technology curve compared to those that remain shackled to the legacy infrastructures of past generations.

More algorithm provider partnerships to come

For its ‘Algorithmic Trading Solutions, 2022: Market and Vendor Landscape’ research report, Chartis analyzed 100 algorithmic trading solution vendors across the Americas, Europe and Asia-Pacific and across asset classes including equities, foreign exchange, futures, options, fixed income and cryptocurrencies. It assessed algorithmic trading solutions providers across 10 market potential and completeness of offering factors, including algorithm strategies’ functionality, algorithm parameters’ functionality, algorithm customer support services, algorithm infrastructure, and algorithm governance. Chartis believes that the Instinet-FIS Execution Services deal will generate significant market potential and completeness of offering gains for the group, and that more algorithm partnership deals will follow. We believe that algorithm providers such as AlgoTrader, BestEx Research, Elwood Technologies, Exegy, Itarle, Pragma, Proof Trading and Quantitative Brokers are ones to watch in the coming years.

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