Daniel Ciment of J.P. Morgan details the development of Brazilian algos and outlines the most effective strategies for trading in Brazil.
Using Algos in Brazil Already accustomed to trading with algorithms or using algorithms to trade strategies in different markets around the world, as international buy-side traders look to Brazil, they want to trade there in the same way they have traded elsewhere. Even though having just one exchange makes the data feed more streamlined, because of the low liquidity profile of certain stocks in Brazil, you cannot use algorithms to trade all stocks electronically. For the more liquid names, many traders are using benchmark algorithmic strategies, like VWAP, percentage of volume, or arrival price. Most algorithmic strategies are based on benchmarks for now, as buy-side traders seek to replicate the methods they use elsewhere, while obviously taking into account the intricacies of the market structure. In the end, if they trade with algorithms in the US, Europe and Asia, they want to trade with algorithms in Brazil as well.
Infrastructure and Volume Spikes This is one of the challenges that we face as an industry. As you are building electronic infrastructures, you have to build for growth and not just for where we are today. When we look at a market, whether it is Brazil or more developed markets like the US, Europe or Asia, we know what we are trading today, but we have to build to accommodate what we will trade in a year, two years and what we think the peak might be. Just because a market trades a couple of hundred million in a day, or in the US, 8 billion shares a day, it does not mean you build your plan to support 8 billion shares a day because a year from now, that figure might be 20% higher.
More so, if a major event happens next week, then that figure might double, so you need to build sufficient headroom. Right now, we can handle a lot more than what we manage on a daily basis, but that is on purpose to make sure that at times of stress we are there for our clients and that they can trade through us with full confidence.
DMA or Boots-on-the-Ground? To be successful in a market like Brazil, brokers need to have people on-site who know the local investor community and know the local financial community. J.P. Morgan has a major trading presence in Sao Paulo, and that is just one piece of the offering in Brazil. For small firms who want access, outsourcing is a realistic option, but if you are going to be big in a market, especially in a market like Brazil, an in-country trading team is required.
Technical Challenges Reliable trading requires market data and telecommunications systems, which are present in Brazil, along with data center space and algorithms that are tuned to the local market and market structures. This tuning includes the liquidity profiles of the stocks as well as the rules and regulations of the exchange; you cannot apply the same algorithms from one region to another and expect them to work. We spend a lot of time and effort, fine tuning our algorithms, testing them on our desk and then rolling them out to clients. It is not just copy-and-paste.
Brazilian bankers are migrating back from New York to Sao Paulo because the bonuses are better. Proprietary trading shops of local banks co-located at the exchanges are battling it out with traders who have just flown in from Chicago. Brokerage firms are rushing to deploy new algorithms to their buyside clients. Exchanges are playing “hard to get” with global exchanges eager to bolster their emerging market credentials. Local technology vendors with relationships are trying to keep out foreign vendors with advanced technology. And everyone’s trying to arbitrage local stocks against American Depository Receipts. Martin Koopman, a veteran of the securities trading industry, shares his thoughts on Latin America’s trading arena.
Latin America (LATAM), dominated by Brazil and Mexico, is growing faster than fortune seekers from the global exchanges, banks and vendors can fly south. The major stock markets are up 400% over the last decade, and the Brazilian derivatives market, BM&F, is now the sixth largest derivatives market in the world with growth of 67% in Q1 2010.
Earlier, Brazil and the rest of Latin America did not receive the same adulation as other emerging market ‘rock stars’, but this changed in 2009 as Brazil emerged early and unscathed from the worldwide financial crisis. Latin America’s time has now come! In the last two years, major exchanges have gone public, trading volumes have soared, brokers have rushed to deploy electronic trading services, early mover technology vendors have racked up impressive sales, and high frequency trading has begun.
Brazil dominates Latin American securities trading with BOVESPA being the largest equity exchange in Latin America. The fully electronic BOVESPA offers low latency market data and connectivity, co-location services, and a FIX Protocol interface. It was in 2007 that Bovespa IPO’ed and in 2008 it merged with the derivatives exchange BM&F, the sixth largest derivatives market in the world with strong volume and growth in interest rate and currency futures.
CME and BM&FBovespa have a cross-shareholding of 5% each and have strong order routing and technology co-operation. Todate, regulators have not allowed any competitors to Bovespa or BM&F and nor are any new exchanges expected to launch.
Local brokerage firms are dominant in Brazil with some being acquired by local banks and out of the 86 Brazilian brokers, 16 are dominant in trading. The largest equity brokers in Brazil are Itau, Brandesco/Agora Senior, BTG Pactual Bank, Citigroup-Intra, Credit Suisse and Socopa, while the largest derivative brokers are Link, Liquidex, CM Capital, Interflow and Arhke. Some local brokerage firms have been acquired by international banks such as Citigroup acquiring Intra in 2008, UBS buying Pactual Bank in 2006 and selling it back to management in 2009, and ICAP buying Arkhe DTVM brokerage in 2008.