“The only problem that Brazil faced during the crisis was with the OTC markets,” says Paulo de Sousa Oliveira, chief business officer of BM&F Bovespa. “In the exchanges, we have tough self-regulation.”
The unusual structure of Brazil’s financial markets was little known outside the country until 2008. But in the ferment of ideas that has followed the financial crisis, the Brazilian model has attracted considerable attention.
The country combines vibrant and vigorous markets with a strict regulatory regime, in which all over the counter derivative and corporate bond trades must be registered with a central depository, Cetip. The São Paulo stock exchange, Bovespa, merged with the derivatives exchange, Bolsa de Mercadorias e Futuros, in 2008, forming one powerful central marketplace for listed instruments.
Brazil is also being proactive about looking for improvements in regulation. Next month a new derivatives council, set up by the Brazilian Banking Federation, will begin work.
“The banks decided it would be quite useful to have an understanding of [end user] risk,” says Oliveira. “We [also] want to gain an idea.”
The new project, announced at the beginning of March, will be known as the Centre for the Exposure of Derivatives Risk (CED). It was formed with the aim of monitoring corporate exposure to derivatives trades.
As in many other emerging markets, some Brazilian exporters got burnt during the financial crisis when the ever-climbing real plummeted against the dollar. Normally this would help an exporter, but some had hedged unwisely against further real strength, leaving them with positions that were deeply out of the money.
The CED will have access, at the beginning of each day, to all notional exposure for the previous session’s trading. This should help lenders gauge potential losses in the event of a default. Brazil’s regulator, the Comissão de Valores Mobiliários, will serve on the council in a supervisory capacity.
Cash and derivatives
Oliveira is excited about the exchange’s latest international project, its plan to create a joint trading platform with Chicago’s CME Group.
“What we are doing first is to ready the exchanges to be able to trade,” he says. “Meanwhile, we are designing the architecture of the system. We are taking stock of everything people trade OTC in Brazil. The idea is to have one platform supporting equities and derivatives. It will be mutually beneficial.”
On paper, it’s hard to fault his logic. CME, the world’s largest derivatives exchange group, has only one notable chink its armour: the lack of an equity trading platform. Enter Bovespa, the largest cash market in Latin America.
The project will be the culmination of a commercial agreement between the exchanges that began in October 2007 when CME took a 10% stake in the premerger BM&F. In February this year, the groups reaffirmed and strengthened their relationship – they now hold 5% of each other.
For BM&F, going into a joint venture with the host of a vast range of products cannot have been a difficult decision.
“What we have here in Brazil is a stronger opportunity to integrate with world markets,” Oliveira argues. “We want to open the country to international investors. We have 500,000 individual accounts at the moment; we want five million, which is nothing internationally.”
Choosing the right products
But organic growth is as important to expanding BM&F Bovespa’s customer base as international alliances.
That partly means finding the products that traders want. Often, product development is dictated by macroeconomic circumstances, as Oliveira points out: “FX is now taking off. [Market participants] have never had to hedge against the dollar before, as it only went one way [against the real].”
From late 2002 until August 2008, the real strengthened more or less constantly against the dollar, from almost R$4 to about R$1.60. Then it fell steeply, hitting about R$2.50 by the end of the year. Since then it has recovered again, to around R$1.75.
Another area of trading that has surged recently is interest rates. The exchange’s flagship interest rate contract, the One Day Interbank Deposit Future, streaked to a record volume of 4.54m contracts traded on Wednesday March 17 – nearly a third of the entire trading in it in February and more than 10 times the contract’s average daily volume in January.
Then the following day, even that record was shattered as 6m of the interest rate contracts were traded. The cause was a widespread expectation that Henrique Meirelles, governor of Banco Central do Brasil and long seen as a safe pair of hands on the monetary tiller, was about to resign to run for political office.
BM&F is determined to keep up with more innovative products geared toward different users, Oliveira says. “Products such as ETFs usually account for 20%-30% [of a stock exchange’s trading volumes]. We are at the very beginning of the market here in Brazil.”
Oliveira also acknowledges that improvements in infrastructure are needed to attract market participants with sophisticated trading models. “We are also at the beginning of algorithmic trading… we have DMA, and now colocation,” Oliveira says. “We know what we have to do to grow.”
Virtues of OTC
Looking ahead, Oliveira stresses the unusual nature of the Brazilian derivatives market. “In Brazil, we have the reverse [of a normal market]; we have 80% exchange-traded and 20% OTC,” he says.
The exchange is keen to address what it sees as a market imbalance. “The first step is to educate the companies,” he explains, to show them the benefits of using derivatives – “basic vanilla stuff”.
“The second is to give the transparency of the price [via on-exchange price discovery]... to give companies a clear idea of risk management,” he adds.
Such a strategy may seem illogical to participants in more established markets – how does an exchange benefit by pushing products away from its trading floor?
“The best way to hedge a position in OTC markets is with a bank,” Oliveira responds. “It’s tailormade. But the secondary [interbank] markets still don’t exist in Brazil… if we had [more active OTC markets], banks would have to offset their risks on exchange. So it’s in the full interest of the company to have a strong OTC market in Brazil.”
Expand and consolidate
BM&F Bovespa is not the only ambitious player in Brazil’s derivatives market. Cetip, the OTC trade registry and bond depository, is newly privatised and eager to expand its services.
Oliveira remains guarded about what role he sees Cetip playing in the development of the OTC and listed markets. “We see Cetip trying to grow and understand OTC... they have a long way to go in growing systems,” he says. “But this is good, to have the capability to compete. To compete with us, they need [central counterparty] clearing.”
At present, Cetip does not function as a CCP, instead offering straight-through-processed trade matching and confirmation to its OTC customers. The depository, which recently signed an agreement with Clearstream, Deutsche Börse’s bond and equities clearing house, is keen to expand its settlement services to the exchange-traded market.
Oliveira, however, is cautious: “It’s [one thing] to think [about becoming a CCP], but to do it is another...” he argues. “It would be a huge step.”
BM&F’s strong growth and base in what will one day be among the largest economies make it an important piece in the global chess game of exchanges.
A year ago, Jean-François Théodore, deputy chief executive of NYSE Euronext, said he expected the world’s exchanges to consolidate to just five or six large groups. Does Oliveira agree? “Of course. Our present partnership with CME is based [on this model],” he says. “We will do whatever we can together. You’re already seeing the integration of the brands.”
But BM&F has ambitions closer to home, first. “Talking about Latin America as a region, we must understand that it’s not a global player,” says Oliveira. “It’s important for us to integrate here first. We are 90% of the market. Our first step is Chile and Colombia. We are trying to integrate order routing, like with CME. We also have Peru on our radar.”
Commenting on the present merger talks between Rofex and Matba, the leading Argentine futures exchanges, Oliveira believes a tie-up would make a great deal of sense. “They need to integrate [with themselves] first, then with Latin America,” he says.
BM&F Bovespa, however, is already looking beyond the Americas. “It’s important for us to go into Asia,” Oliveira concludes. “We are paving our way to address these markets, alongside CME.”
Tom Osborn +44 207 779 8361 tosborn@fow.com