In January of 2009, high-frequency trading (HFT) volumes made up 0.01 percent of all equities trades on BM&FBovespa (BVMF), Brazil’s near-monopolistic exchange. Less than three years later that number stands close to 12 percent, an increase of over 1,000 percent. If the exchange operators have anything to say about it, the HFT elevator won’t stop any time soon.
As the US and European markets struggle their way through the seven stages of high-frequency grief—denial, anger, bargaining, acceptance and so forth—Brazil is feeling no such ambivalence.
It desperately wants additional liquidity and sees HFT as the way to get it. In 2009, shortly after the merger of equities exchange Bovespa and derivatives exchange BM&F, BVMF began a strategic initiative to lure low-latency traders.
In 2010, as a major component of that initiative, it began work on a new trading platform that would solve its latency and capacity issues and attract high-performance brokers from overseas.
“What motivated us was our capacity to deal with flow and the growth we are seeing on the Brazilian market,” says BVMF trading director, Andre Demarco. “We also wanted to add one technology that makes an easy path for the client and the customers in general, because they have only one protocol to send orders to the exchange, and only one protocol and technology to get our market data.”
Work on the Puma trading platform began in March of 2010 with the help of the Chicago Mercantile Exchange (CME). Puma is based on CME’s Globex platform, the world’s first for futures and options.
Two years ago, BVMF’s platform allowed for 50 messages per second per client and latency of over 30 milliseconds, according to Nilson Monteiro, head of the high-frequency direct market access (DMA) desk at Link Investimentos, a local brokerage with approximately 10 percent market share.
Small upgrades improved those numbers to 200 messages per second per client and latency of 20 milliseconds—better, but still far short of the performance needed to sustain HFT practices.
Puma Power
Puma, by contrast, can handle 200 million messages a day. It posts a latency of either one millisecond, according to the exchange, or 1.1 milliseconds, according to Aite Group analyst Danielle Tierney. Puma’s ability to receive orders and produce market data far exceeds its predecessors and its latency figure is expected to drop in 2012.
Gone will be BVMF’s four platforms for different asset classes. Puma offers a multi-asset vertically integrated system with a single code that can support all asset classes. “That’s important for arbitrage, hedging, and all the fun things that HFTs like to do,” says Tierney.
There has been heavy investment in market data feeds and additional, though less substantial, investment in clearinghouse integration.
As a venue that offers lending, settlement, registration, and other full-service perks, BVMF is constantly playing catch-up with itself. Every Brazilian real spent improving one wing means another is lagging behind.
According to Tierney, Puma carries a cost of $200 million spread over 10 years. Testing began in the fourth quarter of 2010. The first half of 2011 was spent tweaking. Puma launched on August 29 with the migration of all derivative contracts from the old Global Trading System (GTS).
First up was spot foreign exchange (FX). Then came the agricultural derivatives contracts—Brazilian commodities like sugar and coffee were migrated from GTS. Next up were financial derivatives, including inflation indices and interest rates. Last were the index futures, effectively terminating GTS.
Next in line for the chop is Mega Bolsa, the equities and equity derivatives platform. That migration is expected to be completed by the middle of next year.
The final implementation will be on the fixed-income side in 2013. Currently, those contracts are traded on Bovespa FIX and Sisbex, for corporate and government securities, respectively.
HFT on the Rise
“The efforts that they’re making are working,” Aite Group’s Tierney says. “You can see it already in the volumes. So if you can see it in one year, I would expect it to look very different in three years.”
HFT in derivatives was at 6 percent a year ago. The latest figures provided by the exchange have it nearly in double digits. As late as April of 2009, it was less than 1 percent.
The brokerage operations of Western investment banks like Deutsche Bank, JPMorgan, Newedge, and Morgan Stanley have had a presence in Brazil for a while. But they are paying renewed attention to the market thanks to the exchange upgrades and an increase in co-location possibilities.
Citi’s director of international electronic sales, Mani Singh, has seen substantial tightening of spreads and decreases in volatility since September of 2010. Co-location, done at one of five datacenters, accounts for 5 percent of equity trading and 6 percent in derivatives.
Monteiro of Link Investimentos says the positive trend goes all the way back to his firm’s implementation of HFT in 2009. “Since we started to send daily orders to BVMF from high-frequency clients back in 2009, the price discovery here in Brazil became much better,” he says. “So spreads tightened quite a lot. We have a big volume on the top of the book being built by high-frequency firms. So, if you are a client waiting to trade, you need a tighter spread and you need a bigger volume being offered on the top of the book. That’s what the high-frequency clients have been doing for the past two-and-a-half years.”
With its entrenched position in the market, Link Investimentos stands to benefit from any additional investor attention, but especially an increase in HFT.
Link, which is in the process of being purchased by UBS, boasts 70 percent of the exchange co-located HFT volume in the country, according to Monteiro. There is no naked access in Brazil, so anyone who wants to take advantage of Puma will have to trade through a local broker. Monteiro also credited HFT and algorithmic trading with increasing the general sophistication of the investment community.
Brokerages like his are protected by the watchful eye of the Brazil’s regulatory body, the Comissão de Valores Mobiliários (CVM). It is difficult to get a license to trade on the exchange, although banks like Citi and Deutsche Bank have obtained them.
The CVM is generally described as a careful but fair regulator. There is a misconception that Brazil is the Wild West simply because it is an emerging market. Yet in many ways, it is more tightly regulated than established markets, even in the new area of high-frequency trading, which should mitigate some of the angst that traditional traders will feel as quants invade São Paolo.
“A lot of the noise that you hear about high-frequency trading is people adjusting to the new market microstructure that high-frequency trading and electronic trading in general has brought about,” says Jose Marques, global head of equity electronic trading for Deutsche Bank. “In the US and in Europe, you can no longer look at a quote screen and have a human interact with that quote. Just like in the automobile business in the 1980s where we had tens of thousands of people displaced by robots, fundamentally changing the way cars were being built in the US, we’ve seen a similar sea change around trading. And it’s very disruptive. Now, that has not happened yet in Brazil. People still trade relatively manually, certainly on the institutional trading side—asset managers and hedge funds and those kinds of participants. As those markets become electronic, it will be disruptive, it’ll create angst, and I’m sure we’ll hear a lot of the same concerns that we’ve heard in the US. There will be some noise, but I think it will be a lot less than you heard here.”
Bringing in Money from Home and Abroad
BVMF’s advertising campaign is aimed mostly at international traders, but it would like to grow Brazil’s fledgling HFT industry as well. At a recent FIX Protocol Ltd. (FPL) conference, the exchange’s US representative, Marcelo Gualda, said that there are only 800,000 accounts nationwide, including foreigners. Soccer legend Pelé is the spokesman for a national campaign to educate the country of 200 million people about the capital markets.
Frustrating BVMF’s efforts to lure foreign HFT into the country is the central bank’s Imposto sovre Operacoes Financeiras (IOF), or financial operations tax. All inflows destined for derivatives, fixed income, and government bonds are taxed at 6 percent, while all inflows destined for equities are taxed at 2 percent. The price of clearing is also considered steep.
The exchange has tried to anaesthetize this sting by charging high-frequency participants less, based on their flow. On a national level, there is no capital gains tax on derivatives, equities, and government bonds. The market as a whole is also considered an attractive one, and, despite its benchmark iBovespa index performing at one of the worst levels in the world, sentiment is generally positive.
“What’s attractive about the Brazilian market is that even with those growth projections cut, the financial system is well capitalized,” says Aite’s Tierney. “They have huge cash reserves, as does everybody in Latin America, because they’ve done well. They haven’t done the silly overleveraging things that we [in the US] have. They have strong domestic growth prospects. They’re not coupled or leveraged to developed economies. For international trade we see big emerging markets are trading with each other. You’re seeing huge flows between Brazil and China, and you’ll see more of that. China has big demand for Brazilian commodities. The emerging markets are basically like a self-contained unit. So that’s why you see, not just Brazil, but emerging markets in general, weather global storms like the Eurozone better than developed markets do, because they have a healthier domestic consumption and international trade profile.”
Although the nation has been on everyone’s radar for a decade or more, BM&FBovespa’s upgrade to Puma and its US-based advertising campaign should have foreign HFT firms taking a second look.
CEO Edemir Pinto told Bloomberg News that he expects HFT volume will soon reach 20 to 30 percent. Though an enormous leap from where the exchange was, that still represents less than half of US volumes.
As long as it does what officials expect and shakes out the liquidity that now exists mostly in the top 10 to 20 listings, it will be embraced in the market, says Newedge’s Evandro dos Reis, Jr., director, co-head, Latin America.
Because of the lack of naked access, says Monteiro, there will not be predatory messaging sent only for the purpose of price discovery.
The pushback could come as discounts for low-latency traders mount, which will put pressure on BVMF’s margins. At that point the discounts will either shrink or the exchange will have to turn to other revenue sources, like its market data feed.
“We think that we’re in the very early stages of a much bigger and better market for firms with this profile in Brazil,” Monteiro says. “So it is an exciting moment we’re living in right now.”
Source:Waters, 29.11.2011 Jake Thomas
