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.
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.