Roundtable: International access to Brazil

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06 October 2011

Derivatives trading in Brazil is booming. And as BM&FBovespa installs its new PUMA trading platform, the country’s growth is set to continue exponentially. However, challenges remain when it comes to international access to the market. We talked to a group of experts about the opportunities in Brazil, recent developments and how best to access the market.

Participants:

Vieri Bracco, executive director , HSBC

Alice Botis, head of business development Latin America, Fidessa

Lucy Pamboukdjian, international business development officer, BM&FBovespa

Chris Gersch, director of portfolio management, Altimus Capital

What recent developments have there been in the Brazilian derivatives market?

Vieri Bracco, HSBC: Brazil has gone through a complete reorganisation and modernisation of trading, particularly talking about futures but also other exchange traded assets such as equities. This process began about three years ago. The exchanges around the world went through an electronic revolution over a long period of time. This is now happening in Brazil much faster and much quicker than happened in other countries. Even in the United States, the CME took ten years to achieve what the Brazilian market has achieved in three.

Co-location, DMA and high frequency trading have really evolved and become established very quickly. When that happens, of course you have a learning curve. This learning curve has been shortened by the fact that Brazil has learned from the experiences of other markets. Errors can be avoided by learning from these experiences.

Alice Botis, Fidessa: I agree. Because Brazil is coming around to DMA later than other regions it has the luxury of looking at other markets to determine what works and what doesn’t. Then, it can employ only the best scenarios.

Lucy Pamboukdjian, BM&FBovespa: The main recent developments in the Brazilian derivatives market are the launching of the new trading platform and also investments in connectivity to be prepared to receive the high influx of trades coming from new players.

We are a new market for some kind of players such as the HFTs and prop shops. We have seen a great response attracting many traders from Europe and the US. Those traders in the market at the moment are the pioneers in the HFT market.

What investments has BM&FBovespa made to encourage international HFT?

Lucy Pamboukdjian, BM&FBovespa: We have invested heavily in making the market attractive for high frequency traders. Our new PUMA trading system, which we have built in collaboration with CME Group, has a processing capacity of 200m messages per day and a latency of approximately 1 millisecond that will be moving down to microseconds in 2012.

The first phase of the migration onto the PUMA Trading platform encompasses FX spot products and derivatives and we will be moving over other derivatives and then equities in due course. Once all trading has been moved onto the system there will significant opportunities for arbitrage and other HFT trading strategies.

We are currently working on integrating all the systems and data centres in order to facilitate high frequency traders and enable better low latency co-location. By 2013, we will have co-location and all of our data centres in one place.

Alice Botis, Fidessa: The new system was a giant step for the exchange. They were looking for a lower latency, higher throughput solution to attract HFT players. The system is very fast, and it can accommodate a lot of flow. And the exchange is giving discounts to high frequency traders to attract more volume.

With the new matching engine, new and different order types can be accommodated. Once the system is live they will be adding new functionality and making it available via FIX, which is important because some markets still don’t offer FIX connectivity for every function and order type, requiring manual entry to fill in the gaps.

Lucy Pamboukdjian, BM&FBovespa: Our markets are growing now and so we have to be as fast and forward thinking as possible in developing new infrastructure to create an environment to welcome investors that are looking to reach Brazil. We have offices in New York, London and Shanghai and are constantly expanding our international interest. We are constantly seeing more and more interest in our market.

Chris Gersch, Altimus Capital : The current structure of Brazil trading markets is such that high frequency trading only constitutes approximately 5% of the equity trading volume and approximately 12% of BM&F’s trading volume. With other major world economies averaging over 50% of their volume through automated execution, such as Germany, Japan and the US, firms like mine identify the huge opportunity for growth. A major breakthrough that is attracting firms like mine is BM&FBovespa’s introduction of the PUMA system.

Previously, my programmers and Brazilian traders had to utilise GTS for derivatives, the Mega Bolsa system for equities and Bovespa-Fix/Sisbex for fixed income and government securities will now be replaced by PUMA. The PUMA system is much more robust and allows easier access for multi asset trading firms to trader their strategies across multiple asset classes. So in my opinion, BM&F made a huge stride towards gaining more exposure and investment firm interest by making this huge technology and infrastructure upgrade with help from the CME.

What kinds of new players have you seen in the market, what are they trading?

Lucy Pamboukdjian, BM&FBovespa: International traders are particularly interested in our derivatives products and we are seeing a lot of activity in our interest rate products. Besides that we have a great variety of products bringing attention of international investors such as the Ibovespa Futures Contracts and its mini version, FX futures contracts, and also the agricultural derivatives.

Vieri Bracco, HSBC: Basically our strategy is to position ourselves to support real money accounts, sound hedge funds that are global and large enough to have an interest in several markets and being serviced by a one stop shop. In addition, while prop houses and HFT players are not at the core of HSBC’s global strategy when they access Brazil they are going to need several services we provide. So on the one hand we are servicing our international clients but on the other we are well positioned to service smaller players entering Brazil.

Alice Botis, Fidessa: I am seeing an increasing number of international players who like to test their strategies from abroad so they can be confident they are effective before investing in co-location or proximity hosting.

There are also terrific opportunities right now for algorithmic players in Brazil. Several international players have adapted their algorithms to the Brazilian market and the local players are partnering with companies, like Fidessa, that offer flexible algorithmic frameworks which allow them to adapt strategies to compete with the algorithms offered by the bigger banks. This kind of competition creates an opportunity for brokers to differentiate themselves in the marketplace.

Chris Gersch, Altimus Capital : Brazil is a large agricultural market with the 7th largest economy in the world. People know about the sugar trade but perhaps not about the oil and ethanol markets or that it is the second largest iron ore market in the world. We are moving onto PUMA and will be trading our pattern recognition software across almost all of the derivative products.

How can international traders access Brazil?

Alice Botis, Fidessa: There are four ways to access Brazil. First, you have traditional DMA where a client accesses the BM&F and Bovespa segments through a brokers’ existing connectivity. Fidessa offers this, along with a robust risk module, to a number of markets across the world.

You can also obtain access through a DMA provider. Under this model, the client accesses the exchange through an authorised access provider which allows the client the flexibility to be sponsored by multiple brokers. We are not certified for direct DMA yet, but we are currently installing lines and will be very soon. Once we have the direct access, which we will use for UMDF data distribution as well as connectivity, we will be ready to offer this model to our clients. I’m not currently seeing a huge demand in the marketplace for this kind of access.

The third option is direct DMA where a client connects directly to an exchange using their own infrastructure. Finally, there is co-location, where a client installs their own computer within the exchange’s facilities.

Additionally, we are getting a lot of enquiries about proximity hosting. Local brokers that are sponsoring flow into the exchange are asking for a risk check that will mimic the exchange’s. Fidessa’s risk module offers the additional benefit of combining risk checks for equities and derivatives into one solution, giving sponsoring brokers higher visibility into their risk scenarios.

What considerations should investors have preparing to set up in Brazil?

Vieri Bracco, HSBC: The initial challenge is opening an account in Brazil. It is a complicated market to access, complicated for documentation reasons and for its regulatory constraints. Brazil is a final beneficiary market and if you look across the world at final beneficiary markets you see that they are more complex to access.

You need a local legal representative and a custodian before you even start to think about execution. You need to have a deal with a bank in order to guarantee your financial flows in and out of the country. You need a bank also to buy your treasury bonds to post as collateral at the exchange. These are the sort of services that you must consider.

Chris Gersch, Altimus Capital : If you want to co-locate your office, you had better be ready to hire some Brazilian employees. You have to have local representation. That was the biggest challenge for us but one of our traders came from Brazil and so we had someone we trusted there to run the team but that is a big hurdle for others – it has been one of our tactical advantages and could be a big roadblock for some people.

The registration process is tedious. It took us 18 months and we had in house legal teams to deal with it. The turnaround to create a firm takes a long time and you have to spend a lot of time knocking on doors. Things get done a lot slower.

Alice Botis, Fidessa: The first thing is to understand what paperwork they have to fill out to be able to trade. The exchange has representatives across the world to assist with this. These representatives can guide the firms through the process of signing up, understanding the intricacies of local tax scenarios and the impact of trading directly into Brazil.

A lot of people use buzzwords such as DMA and low latency, and my job is to sit them down and ask them questions about exactly what they are trying to achieve. You have to understand their business and work with them to architect a technology solution that will enable them to achieve what they want to.

Sometimes people will say they want low latency HFT access to the Brazilian market from Chicago. There is a minimum of 65-70 milliseconds from Chicago to Brazil so that has to be taken into account when developing a plan of action. You must also consider whether they are going directly into the exchange or through a broker first. Fidessa works consultatively with our clients to help them figure out the best technology set-up for their unique trading requirements.

Lucy Pamboukdjian, BM&FBovespa: I agree. Different traders have different requirements and we are here to help them find the entry point that suits them best.

Once you have registered, and set out your strategy, what challenges are there?

Vieri Bracco, HSBC: Once you get over the wall and you are in the country, set up to trade, the next challenge to trading derivatives is the technology aspect. This has been proven to be a challenge for clients. Hardware in Brazil takes longer to obtain and it is much more expensive to buy than in developed markets.

If you want a server for co-location or a simple desktop, it can take time and a large organisation with global agreements with the large vendors and technology companies can cut the time taken down.

Ultimately, you need local help a lot more in Brazil than you do in other, more developed markets. This will change but for now, external vendors and clients coming into the country will face challenges that we can help with.

Lucy Pamboukdjian, BM&FBovespa: A key difference in our markets is the fact that all trades are processed in the name of the final beneficiary, which may be surprising for international investors. We don’t have accounts where positions are traded by the broker or the intermediary in Brazil. All the trades are done in the name of the final beneficiary investor.

This may cause some confusion but at the end of the day positions will be under their name and if by any chance the agent in the middle of the transaction fails, positions will be in the name of the customer and even in the case of default by an intermediary, positions are safe in the name of the customer. This might be seen as a challenge at first but, the importance of this was proved during the financial crisis.

Alice Botis, Fidessa: In addition, the risk checks in Brazil are very specific, they have a number of rules that you have to abide by. Right now, they have separate risk checks for equities and for derivatives. The benefit of a brokerage firm using a vendor solution like Fidessa’s outside of the exchange is that they can abide by both sections’ risk checks and then monitor the total risk of a client by looking at both sides. As of right now, as long as the third party risk check can operate in the same way as the exchange risk check, they will let the trade through. However, the debate around where risk checks should reside – be it at the broker, the liquidity vendor or with a third party provider – continues to rage on.

How is the clearing model structured in Brazil?

Lucy Pamboukdjian, BM&FBovespa: Clearing is vertically integrated into the exchange. The clearing, settlement and CCP for equities, derivatives and all the products that we have traded in our markets are done centrally. Post trade is an important part of the infrastructure in Brazil. In the 2008 crisis and during periods of volatility, no one has ever failed on the exchange.

We have four different clearing houses, one for each group of products: equities, derivatives, FX spot and corporate and government bonds. These are a legacy of pre-merger market structure and the four clearing houses that the two exchanges had previously. A very important project that we have is to integrate all the clearing and collateral facilities to grant investors more efficient ways to post collateral. We are working to enhance the post trade environment and aim to have it all integrated by the end of next year.

Chris Gersch, Altimus Capital : You can overcome the fragmentation. We have been fortunate to have relationships down in Brazil and have managed a system that aggregates the clearing houses and gives us the best bid offer so that we can execute the trades in a completely automated manner.

What services are Brazilian firms offering to international investors so they can access these opportunities?

Vieri Bracco, HSBC: The presence of HSBC in this market is at the core of our global strategy. Brazil is a key strategic market for our wholesale bank and broker business. We are building up and putting ourselves in a position to compete and leveraging our strengths and expertise in facilitating our clients’ international business in accessing Brazil.

We are a large global financial conglomerate and we can afford to make the large investments with reduced costs compared to the competition. We have the economies of scale to benefit from global deals with vendors.

Alice Botis, Fidessa: International investors seeking to locate their strategies in Brazil find it can be expensive, confusing and sometimes frustrating because of the lack of language skills and understanding of the local processes.

I am starting to see Brazilian firms offer services where they will co-locate or proximity host the investors’ strategies for them and take responsibility for all of the infrastructure required including hardware, rack space, telecommunications lines to the exchange and market data. All of this will be offered in exchange for sponsorship commissions. It is still a new trend, but it suggests we will start to see significant changes in how business is done in this marketplace very soon.

What low latency and algorithmic trading solutions are available for international investors?

Alice Botis, Fidessa: There are a number of vendor technology solutions available to accommodate low latency algo trading, and there are several international brokers who have adapted their algorithms to work in the Brazilian market. Based on the latency profile of some of these strategies, they will be able to run from the US.

Many of the local brokers are aggressively enhancing their technology and in-house algorithmic expertise to compete with the larger more established global players and they are looking to provide more refined strategies which are designed to take advantage of the intricacies of the Brazilian and Latin American markets.

In light of the recent tax hike on interest rate trading in Brazil, should investors be concerned about rule changes in Brazil?

Vieri Bracco, HSBC: What I tend to say to clients is that rules change, taxes are implemented. This is clearly a sign that the government wants to target speculative flows into the country. However, this is not unique to Brazil. In a country that has one of the highest interest rates in the world, it is natural that you will be targeted by speculators who see that as an opportunity. What Brazil doesn’t do is put up a new tax and made it retrospective. This is something that has always been the case and is at the base of our legislature.

What does the future hold for Brazil?

Alice Botis, Fidessa: The potential in this marketplace is enormous. It is so exciting for us to see it unfold and be one of the early technology providers to serve this marketplace. Brazil and Mexico are already large, established markets and Chile, Columba and Peru are all beginning to interconnect. The region is coming together and they know that the rest of the world is watching. They understand the need to do things right in order to attract investors. We are going to look back at this growth period in five years and be amazed. Fidessa is opening an office in Sao Paulo and we are really excited about the future there.

The exchange has introduced progressive price discounts of up to 70% based on a HFT's daily trading volume, and they are making a number of technology and infrastructure enhancements with the introduction of PUMA as the first step to increase volumes and improve messaging rates. All of these exciting developments are only the beginning and we look forward to watching it unfold first hand.

Chris Gersch, Altimus Capital : Brazil is a thriving derivatives market. My clients want to know how there is a ten year 350% return on the equity index compared to 14% on the S&P. They want to know how to get involved. It is now a reality that we can trade the derivatives in Brazil with launch of the PUMA system.

Lucy Pamboukdjian, BM&FBovespa: We are really optimistic. The technology investment will be fully up and running by 2013 and we expect to see a continuation of the increased international interest from HFT traders.

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