By Christian J. Zimmer and Hellinton Hatsuo Takada, Itaú Asset Management.
The electronic trading landscape in Brazil is highly connected to BMFBovespa. Fortunately, BMFBovespa uses FIX as their communication protocol. However, the adoption of FIX does not imply the possibility of electronic execution of an order of any security and any size. At BMFBovespa, mostly equities, a few futures and some option contracts have significant liquidity for electronic trading. Obviously, when executing large orders electronically, it is necessary to have liquidity to avoid price distortions and, at BMFBovespa, possible unscheduled auctions.
On the other hand, BMFBovespa recently introduced the PUMA trading environment which reduced the execution time significantly. This system was developed by BMFBovespa together with the CME and started at the end of 2011 as the new platform for derivatives. During the first half of 2012 the migration of stocks and stock derivatives was concluded too. In the future, the fixed-income platforms Bovespa FIX and Sisbex (from the Central Bank) are supposed to migrate to the unified PUMA platform.
Additionally, the BMFBovespa’s market data feed is now faster with UMDF/Fast FIX. In the marketplace, we can state with confidence that there is now a mature technology setup for exchange-traded assets.
But there is more – especially, when it comes to the question of liquidity and the integration of other markets and functionalities. Firstly, let’s take a broader view of the trading environment. When it comes to government bonds, two platforms are the most relevant in Brazil: CETIP-Trader and Bloomberg. Additionally, there is the BovespaFIX environment with focus on corporate bonds, which is under reformulation and a new service is to be launched in mid 2013.
Many broker-dealers display their prices via individual Bloomberg screens or they can be aggregated into a Bloomberg function. The same happens for many options: broker-dealers offer screens where the clients can also follow the morning and afternoon auctions.
Finally, even in the equity space trading of big blocks is still a manual process where the brokers look for counterparties. Information leakage is potentially very high.
The Darkstone project In order to achieve better results in big blocks for equities, Itaú Asset Management (IAM) started at the end of 2012, the Darkstone project. IAM is one of the largest asset managers with a focus on Latin America with approximately USD300 Billion AUM. Big asset managers outside of Brazil typically access dark pools and other alternative venues for executing big positions. The lack of alternatives to Bovespa for stock trading has made it common practice to find counterparties for blocks via phone/chat with the broker-dealer. After agreeing on the price they cross the parties and inform the exchange of the trade. The trade is thus a Bovespa direct cross, not a broker internalisation. Unfortunately, this manual process opens the door for operational errors – following about 20 chat windows and negotiating terms with all of them is not easy when the market becomes nervous. Therefore, in 2013 we started to connect our brokers and to negotiate big blocks with them based on the IOI-platform from Raptor Trading Systems.
By now, three alternatives, all based on the FIX Protocol, are possible for arranging the trades:
Acceptor approach: This alternative represents the typical IOI flow where the broker basically sends an IOI and receives a NOS as a response. In order to better guide the brokers, at the beginning of the day, IAM sends a list of stocks we intend to trade. Then, during the day, at any time, the brokers can send actionable IOIs. If our traders have posted a corresponding order into Darkstone, immediately a NOS is created and sent to the broker. A fill execution report is expected from the broker. The advantage of IAM is the reduction of footprint in the market.
Initiator approach: Following a performance based ranking per stock, IAM sends IOIs to the first broker. The IOI has a 5-10 minutes lifetime with price replaced as the markets move. If the sell-side trader finds a counterparty, he sends a referring IOI and the flow continues as in case 1. If the sell-side trader does not find a counterparty, the IOI is canceled and sent to the next broker in the ranking. As this alternative creates a certain footprint, our traders observe the participating brokers’ market behavior. Any misbehavior has the consequence of excluding the broker from our list.
Broadcasting approach: Like in a classical auction, we invite our brokers via RFQ to give us a price for a defined position. If no satisfying price is received, IAM’s traders may step back and not trade at all. Once again, the market footprint is a critical concern.
As Brazilian laws do not allow for internalisation, this is not a dark pool setup and all the trades are sent to the exchange and registered there. The prices and quantities we promote are constantly controlled within the Raptor system to avoid unscheduled auctions going to the market.
Of course, making direct crosses is already very popular in Brazil. But it is based on chatting, and making it FIX-based allows for a relevant increase in efficiency. Further, we expect in the near horizon the maintenance of the total trading volume from direct crosses and a fair performance-based evaluation of our brokers.
Fabricio Oliveira, Head of Risk Management at Mirae Asset Global Investments Brazil, discusses his approach to pre-trade risk controls and how local market structure influences the occurrence of risk.
Market Open At Mirae we do much of our trading with offshore entities. For example, we have funds that are administered in Hong Kong, Luxembourg, Brazil, US and Korea and this geographical disparity creates operational risk. Differences in settlement price, currency and the timing of financial transfers are all aspects that must be considered when using offshore funds. The ability to settle a US trade in the US and not in another time zone is also important. This is particularly true of Hong Kong as our time difference is a huge barrier to trades in Asia. It is almost impossible to book these trades in Hong Kong even though our traders here see the opportunity to do so.
When I focus on the risks for open trading, the settlement movement is an important concern. Whether you are focused on market risk or liquidity risk, all risks need to be monitored, so you can have a clear view of what potential risks lie ahead.
High Frequency Trading There is much discussion in the industry and at conferences about high frequency trading (HFT) in Brazil, but we are not yet ready for high frequency strategies. The industry is starting to see how HFT works, but liquidity in Brazil across asset classes is insufficient to support these strategies. There are approximately 300 listed companies in equities and about half that number in derivatives, whether in bonds or yield curves or currency. The local players who run HFT strategies focus on the few stocks and derivatives with liquidity, which does not give them many options to find alpha over short periods. It will be interesting to see how it works in North America and Europe and for us to consider what might be possible in Brazil. For now, I do not see many players in HFT and I can count on one hand the number of funds using HFT.
Our pre-trade risk controls have not had to account for HFT volumes and speeds yet, so we have focused more on core control mechanisms. We have some vendors who can produce risk controls for the current liquidity. If we have liquid stocks, derivatives or OTC products, then we can define our own risk controls. Fund houses with hundreds of funds will have difficulty in applying those controls to the trading systems, but as Mirae mainly focuses on equities, our implementation burden is much lower. Today, all our pre-trade risk controls are done in real-time, including automatic limits. Beyond this, we still have a layer of control in the trader on the desk.
Working with Brokers When discussing risk controls, it is important to mention that in Brazil all brokers employ significant risk controls on their side, to prevent them from taking on more risk than they can carry. When the brokers start to trade with the exchange, the exchange provides them with risk guidelines and limits. As clients of the sell-side, buy-side desks cannot exceed their assigned broker limits and their orders will be automatically paused if the broker’s limits are reached. The broker’s risk controls are complete; they will not take on risk. As a result, their clients do not have much help in implementing their own controls. This is exacerbated because a fund house may trade with many brokers – in our case we deal with 35. It is impossible to implement one solution per broker, so we rely on our OMS provider to connect with the brokers and to match up risk controls.
Richard Nelson, Head of EMEA Trading for AllianceBernstein, shares his perspectives on navigating volatility, prospects for developing exchanges, new regulation and the balance between transparency and best execution.
FIXGlobal: How much does volatility affect the way that you trade and what are you using to measure volatility on the desk?
Richard Nelson, AllianceBernstein: We use an implementation shortfall benchmark, so the longer we take to execute an order, the wider the range of possible execution outcomes. Volatility, in particular intraday volatility, increases that potential range, so you could see very good or very poor execution outcomes as a result. In reaction to that, we take a more conservative execution strategy or stretch the order out over a longer time period. And, for instance, if we get a hit on a block crossing network, we will not go in with as large a quantity as we would in a less volatile market. In that way we try to dampen down the potential effects that volatility might have on the execution outcome.
FG: How is AllianceBernstein using technology to improve performance and cut costs on the trading desk?
RN: It plays quite an important part and has done so for quite a while. We are pretty lucky in that we have a team of quant trading analysts. Most of them are in New York, but we have one here on the desk in London, and they help us to analyze the changing market environment and recommend the best ways we can adapt to it. Our usage of electronic trading has increased in the last year, we benefit from the quant trading analysts looking at the results we are achieving with our customized algorithms. We are more confident about getting good consistent execution outcomes because they are monitoring the process and making the necessary changes to ensure the results are what we are expecting. This, in turn, increases the productivity of the traders I have on the desk. They can place their suitable orders into these algorithms and let them run which allows us to focus on trying to get better outcomes on our larger, more liquidity-demanding orders.
On top of that, as market liquidity has dropped significantly, we are trying to make sure we reach as much potential liquidity as possible, and ideally we want to do that under our own name rather than go to a broker who then goes to another venue. We believe that going directly into a pool of liquidity is better done under your own name rather than via a broker because we can then access the ‘meaty’ bits of the pool rather than the ‘froth’. We are looking into ways of doing that but one of the problems is that, potentially, you get a lot of executions from a number of different venues, which results in multiple tickets for settlement. Our goal is to access all these potential liquidity pools, yet also control our ticketing costs, which are a drag on performance for clients.
FG: Was it an intentional change to increase electronic trading or was it a byproduct?
RN: It was a little of both. Our quant trader has been with us for two years and when he first arrived he had to sort out the data issues that exist in Europe and to clean things up. Once the data integrity was sorted out, we looked at different ways of employing quantitative analyses. Having somebody here who is constantly monitoring the execution outcomes means we can proceed down this path with real confidence. As a London firm, we were a little behind in our adoption of electronic trading, but now we are in the middle of the pack in terms of usage. It makes sense from a business and productivity perspective that there are many orders that do not need human oversight, which are best done in algorithms.
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.
CME Group’s Fred Malabre and Don Mendelson chart the history of electronic commodities trading and discuss the recent improvements in FIX for commodities, including fractional pricing, trading listed strategies and faster market data.
Adoption of FIX for Commodity Trading
Products traded on CME Group exchanges have many underlying asset classes, including commodities, interest rate instruments, foreign exchange and equity indexes. Although the largest share of products traded today on our platforms are financial futures, the history of our markets began with agricultural and livestock commodities. The underlying physical commodities include the petroleum complex, agricultural products such as soybeans, wheat and corn, and metals such as gold and copper.
Listed contracts in all of our markets include futures and options on futures. The futures contracts can be physically settled, meaning that a seller has an obligation to physically deliver the commodity to the buyer when the contract expires at a delivery point specified by the contract, or cash settled, which are products that could not be settled to an index.
Back in 2001, we were at a crossroads. At this time, futures contracts were primarily traded via open outcry – brokers shouting and waving arms in trading pits. At that time, CME launched its first FIX compliant interface to electronically match orders for a wide range of asset classes ultimately including equity indexes, FX, interest rates, real estate, weather, economic events, energy, metals and agriculture. The question arose: how do we represent orders and execution reports and transmit them between firms and the exchange? We had earlier put out its own order routing API, but it had some drawbacks, including the high level of software developer support required. Firms were running several different computing platforms, for example.
At that time, the FIX Protocol had begun well in the equities world. It was attractive because it was not an API, but rather a standard for message exchange. From the exchange’s perspective, this was an attractive proposition: we would develop our side of the conversation, and firms would develop theirs. From the firms’ perspective, their software developers could achieve high performance, only limited by their own imagination and skills.
It seemed that with a few adjustments, FIX could be adapted for futures and options trading. In version 4.2, fields were added to support derivatives, including expiration and strike price. We participated in working groups to standardize those changes, and later helped spawn FIX-based solutions for market data and FIXML for clearing.
An example of a problem with adapting an equities standard to commodities is fractional pricing. Traditionally, agricultural prices were stated in fractions. To this day, soybean futures are quoted in increments of ¼ of one cent per bushel. US equities made a leap from fractional to decimal pricing in 2001. Although trade pricing stuck with tradition, we decided to follow FIX conventions with decimal pricing in messages.
We added some custom indicators within our FIX interface to facilitate conversion to a fractional display. One indicator represents the main fraction and another represents the sub-fraction. For example, for a product ticking in ½ 64th, we would send the main fraction as 1/64 and the sub-fraction as ½. These indicators could then be used to convert a decimal price used over our FIX interface as 105.0390625 which would then be converted to a screen display as 105 2.5/64th. We found that the FIX Protocol is easy to extend to add custom features and can easily be extended for legacy needs with negligible impact to customers not using new tags such as the custom indicators talked about previously.
Itaú Asset Management’s Christian Zimmer and Hellinton Hatsuo Takada drill down into the usage of FIX in Brazil, isolating the areas where FIX is developing and where there is room to grow.
The BM&FBOVESPA (BVMF) initiative to provide market data using FIX is just the beginning of moving past the basic usage of FIX in Brazil. FIX is being implemented under the Unified Market Data Feed (UMDF) banner with the objective of integrating the traditional FIX market data and Multimedia Multiplexing Transport Protocol (MMTP) market data streams. The communication efficiency between these two needs to increase a lot, because in Brazil the trading community is starting to go beyond the simple use cases for FIX.
Besides the FIX implementations, one example of this development is the FPL initiative tasked with creating a version of the FIXimate in Portuguese, which the local FIX engineers are contributing to. In the last FPL meeting in Brazil, the local public seemed to be a little bit more aware of FIX, while the use of the FIXimate in Portuguese indicates a growing development of FIX solutions in Brazil.
Currently, some brokers are providing simple execution algos to be used in the Brazilian market. However, these are not delivered via FIXatdl, but via an algo-number indicated in a general purpose FIX-tag. Currently, the algos offered are very simple: mainly VWAP, TWAP, Iceberg, and POV. More sophisticated algos that try to gain some alpha are present too, but they are not originally created by Brazilian market participants. These kind of algos are normally developed from global brokerage firms at their headquarters in the US or Europe and then applied/adapted to the local market (what we call tropicalization).
Even if the algos were customized by the international firms to fit local market data, we have our doubts that on the actual trading floor there are many buy-side traders using these advanced methods. There are mainly two reasons for the nonusage of the advanced algos. First, there is a lack of confidence whether international teams understand well the local Brazilian market. Second, most of the time the big buy-side firms have mandates to achieve a 100% fill rate – something not guaranteed by the alpha-creating algos. This demand originates from the way the big asset management firms work in Brazil: they are more fundamental, and focused on allocation rather than trading.
The usage of FIXatdl could improve the usage of algos because of its standardization, but it is still hard to move forward on this issue.The sell-side seems not to be too enthusiastic, and thus, does not provide the buy-side with this efficient alternative. The buy-side is also not demanding it, which implies that there will be no advances.
In addition to FIXatdl, we expect the efforts of the FPL High Performance Interfaces Working Group to become applicable in the Brazilian market. The success depends on, obviously, if the exchange permits a separated access to their matching engine with this protocol dialect. But as there is always demand for lower latency, the outlook is positive for this initiative. The same might be true for the FPL Inter-Party Latency Working Group. Although there are hardware solutions to this problem and these hardware solutions may create less additional latency, it seems to be much easier for any mid-sized firm to use FIX-based latency analysis rather than buying an expensive system just for this purpose.
Christian Zimmer, Head of Quantitative Trading and Research, and Hellinton Hatsuo Takada, Quantitative Trader, of Itaú Asset Management reveal the truth about high frequency trading in Brazil.
Conference panels, discussions and articles on High Frequency Trading (HFT) generally start with its definition. The term HFT is like ‘Cleopatra’ – sexy and mysterious and everyone is keen to know more about it. But the term HFT speaks for itself, so is it wasting time to go over it again?
Probably, because the term ‘high’ only has meaning relative to an external point of reference, just like cold, hot, sweet or other adjectives. This subjectivity is all the more interesting, as it is extremely difficult to measure an investor’s brief holding period in most financial markets and, therefore, determine if it really is ‘high’. Unlike in the US, where the exchanges do not register the origin of the trade, Brazilian regulation allows BM&FBOVESPA to identify the final client on every trade. Consequently, it is much easier to measure the holding period of an investor for each asset. Also, this rule is the means by which the exchange determines whether an investor’s trade is classified as a ‘day trade’ and is thus eligible for reduced fees.
Naturally, BM&FBOVESPA does not classify a trader opening a position in the morning and closing it at the end of the day as a high frequency trader. There should be far more trading than this to qualify as HFT. But how much more? It depends on the exchange’s criteria and reference point for ‘high’.
Figures for HFT published by BM&FBOVESPA in their April 2011report show 3.9% of the BM&F segment is high frequency and 5.9% of the BOVESPA segment. Consequently, the reduced fees are presented to the Brazilian trading community as less of an issue, as they say there is evidence of HFT taking hold. But HFT volume is not really increasing and is still far off the US figures which are often cited at around 60-70%. After carefully observing BM&FBOVESPA market prices, it is easy to conclude that it would take some time (possibly hours) to have a change in the prices sufficiently large enough to pay the transaction costs.Remember that HFT strategies are very sensitive to transaction costs.
Our suggestion is to step away from making subjective references to ‘high frequency’. Instead, one should look at the underlying trading strategies. The incentives an exchange should create to attract flow must be adjusted to the strategies that are really needed. Each strategy deserves a different set of policies and this will help the diversification of the traders’ strategies.
A trader using a market maker strategy can live with exchange fees as long as the bid-ask spread is sufficiently high. If the spread narrows, the costs become crucial and the exchange must lower the fees in order to keep this client in the market. On the other hand, a directional trader has different issues; if the fees are high, a trader must wait longer for a relevant price move so that they can capitalize on their position. Contrary to the market maker, the directional trader loves to see narrow bid-ask spreads. There would be no need to lower fees when the spread is close. The same is true for the statistical arbitrage traders.
When looking at the third party analyses of HFT in the international markets, we often see that the most common strategy is the market maker approach. This fact is strongly influenced by market fragmentation, which we do not have in Brazil. Fragmentation creates new intermarket trades, which could qualify as arbitrage trades, but not necessarily as market maker trades. Fragmentation also makes exchanges and other venues compete for the customers that provide liquidity and, as a result, give incentives to market makers. As mentioned above, Brazil does not have a fragmented market and BM&FBOVESPA does not see it necessary to ask for more liquidity. At least not as long as international capital flows are strong and increasing. Liquidity is needed in second tier shares and below.
Andres Araya Falcone of the Santiago Stock Exchange explains how FIX is increasing the range of services available to traders in Chile and throughout Latin America.
How is FIX facilitating DMA into the Santiago Stock Exchange?
The first concept of DMA in Chile began with what we call “direct traders” (buy-side traders) facilitating these specially authorized institutional clients, to send direct orders to the market via a “broker sponsor”. Thus, pension and mutual funds, insurance companies and other institutions, using trading terminals provided by the Stock Exchange, can trade directly in our market. The next natural step was the incorporation of electronic networks to attract order flow from the U.S., Europe and neighboring countries in Latin America, especially Brazil.
In 2006, we built the first FIX interface using version 4.0 to connect to the Marcopolo Network, to attract the order flow of our local equities market. After that, the Santiago Stock Exchange launched its initiative to modernize the equities electronic trading system and developed Telepregón HT, jointly with IBM, which went live in June 2010. This system is ready for algorithmic trading flow since it supports a throughput of over 3,000+ orders per second with sub-millisecond latency. In designing the system, we decided to use FIX 4.4 to enable easier connection via DMA with other exchanges, sell- and buy-side firms and market information vendors. This has greatly facilitated the connection to different networks, such as Bloomberg, Fidessa and SunGard, among others. For all these initiatives, FIX has been crucial in facilitating the integration with these listed networks. During 2011 we will announce new network agreements.
Currently, referring to the equity market, 11% of order flow comes from DMA which represents an average of a 27% increase over the last 6 months, today 19% on average comes from Internet retail order flow, and the rest comes from traditional OMS and Trade Work Stations.
As foreign investment into Chile and the Chilean market continues, how will the Santiago Stock Exchange upgrade its platforms to meet increased investor and trader demands?
In 2010, the Selective Share Price Index (IPSA), the country’s main stock market indicator, gained 37.6% in Chilean pesos (equivalent to some 46% in dollars). Share trading on the Santiago Stock Exchange rose to US$60 billion in 2010, up 30.5% from 2009, setting a new annual record. Trading was particularly strong in the second half of the year, which accounted for almost 60% of the annual total, reflecting strong demand from both local and international investors.
At the same time, by the end of 2010, the Santiago Stock Exchange had signed a linkage agreement with Brazil’s stock exchange, BM&FBOVESPA, heralding the latest in a series of cooperativeprojects being run between Latin American bourses. The agreement, signed on December 13th, will enable connectivity between both exchanges for order routing and market data dissemination. It also includes separate initiatives for further development of the Santiago Stock Exchange’s derivatives market, the establishment of joint initiatives related to settlement, clearing and central counterparty services, as well as access to the BM&FBOVESPA /CME trading platform from Chile.
Market participants in both countries will be able to route orders for stocks, stock options and related derivatives listed on the other’s exchange. Both exchanges will also be able to receive and distribute each other’s market data. Clearing and settlement of orders will be done according to local market rules of listed instruments. These kinds of initiatives imply that the Santiago Stock Exchange’s IT platform has to be prepared to manage more than 6 million orders per day.
What plans does the Santiago Stock Exchange have to accommodate High Frequency Trading and algorithmic order flow?
We are working as an integrator of a state of the art product for algorithmic trading. In conjunction with Streambase, FIXFlyer and IBM WFO, we are creating a product we will call “Broker in a Box”. The idea is to provide a framework for capital markets, including a set of algorithmic order execution strategies designed to achieve best execution, access liquidity, minimize slippage and maximize profits for trading operations. These algorithmic trading strategies (like VWAP, TWAP, Arrival Price / Implementation Shortfall, etc.), are provided as fully customizable EventFlow modules which can be used in conjunction with the frameworks. Trading firms will be able to modify each algorithm to reflect their own “secret sauce” and to differentiate their trading strategies in the market. The Santiago Stock Exchange will provide an “all in one” solution: integrated markets, market data (from Integrated Latin America Market (MILA), NYSE and NASDAQ), co-location, monitoring, local support, etc.