Barrier to Entry: Buy-side Pre-trade Risk Controls
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.
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.