Botis: Latin America poised for growth

Botis: Latin America poised for growth

Research from Kimsey Consulting predicted that the region could expect the largest global increase in firms with trading operations between 2009 and 2012.

An expanding middle class with attendant pension funds combined with a positive population growth trajectory has encouraged the establishment of an investment management community, and the consequent growth in both buy-side and sell-side institutions. From 2000 to 2010, access to financial services in Mexico increased from 25 to 59 percent, according to a survey conducted by the Ministry of Finance and Public Credit (SHCP).

But this is not the whole story of the region’s market expansion. Another driver behind the growth in LATAM markets is coming from foreign investors who are seeing the region’s potential and seeking out new opportunities.

As one of the BRIC nations (the related economies of Brazil, Russia, India and China), Brazil has long been regarded as a potential economic powerhouse of the future. Chile has joined Mexico as a member of the Organisation for Economic Co-operation and Development (OECD)—another indication that the region is able to offer an appropriate environment for investment and investment businesses. Commodities and commodity derivatives remain a strong growth area for global trading. The lure of markets rich in natural resources combined with the reassurance offered by political and economic stability has opened up the region in the eyes of multinational banks and their investors.

If the political and economic structure of these countries is now considered stable and safe, then so too are their capital markets. The final factor in the growth of foreign interest is the improved regulation and supervision of markets. Mexico's banking and securities regulators, including the Comisión Nacional Bancaria y de Valores (CNBV), Bolsa Mexicana de Valores (BMV), and Asociación Mexicana de Intermediarios Bursátiles (AMIB), have worked to bring the nation's corporate-governance guidelines in line with international norms. Additionally, the Comissão de Valores Mobiliários CVM, Brazil’s banking and securities regulator, and the BM&F Bovespa’s regulatory and market-structure changes will impact the way exchanges and brokers operate.

That general trend has been given extra impetus by the region’s weathering of the financial crisis. Broadly speaking, countries in LATAM had high levels of international reserves, manageable current account imbalances, low debt, and minimal exposure to “toxic” assets and foreign funding. Weaknesses in the US dollar, rapid growth in commodity prices, and the consequent influx of capital have undoubtedly helped. Growth rates in national ETFs are an indication of recent success: The iShares MSCI Chile Index (NYSE Arca: ECH) went from 33.65 in 2010 to 71.36 in 2011, which was an increase of 112.06%. The iShares MSCI Mexico ETF (NYSE Arca: EWW) went from 27.69 in 2010 to 60.76 in 2011, which was an increase of 119.43%.

The recovery is expected to be supported by a better global financial and economic environment, a continued increase in commodity prices, and more capital inflows. If the economic crisis can be viewed as an example of what economists term "creative destruction," then LATAM is regarded as a solid foundation for the next period of growth.

Consequently, local brokers are looking at two distinct groups of potential customers. The first is, inevitably, foreign buy-sides who need access to local markets in the traditional manner. The second, and equally important, is foreign brokers who choose not to set up their own local establishment and instead join the exchanges themselves. Their wish is to route orders to partners who are member brokers, and by so doing, gain access to LATAM markets for their clients. In addition, these local brokers are also keen to expand and enhance the range of services they can offer to other local players as well as to the international community.

Of course, these broad brushstrokes about the LATAM region hide some important differences in the capital markets of each Latin American country.

Contrasting cultures

In Brazil, where local firms are well-established, the use of at least a basic EMS is fairly common. BM&F Bovespa has focused on unifying its two disparate technological platforms into one. In general, the old technology platforms are being replaced with a single high throughput matching engine, including a new unified FIX based gateway called EntryPoint and a new market data feed called UMDF (Unified Market Data Feed). High-frequency and algorithmic trading are of great interest in Brazil, whereas in Mexico, pairs, basket, and algorithmic trading are growing. Mexican markets have also seen the highest number of market makers in ETFs in the region. The penetration of truly comprehensive trading platforms in Mexico is limited at present, but the demands of foreign investors are likely to change this going forward.

Both countries are now facing new regulations and market-structure changes. In Brazil’s case, there is a high demand for DMA-type 2, 3 and 4 for equities and derivatives, which highlights the need for tools to perform pre-trade compliance checks. Also, recently BATS announced that they will open a new exchange in Brazil which will introduce a broker's requirement to look across multiple markets and make routing decisions based on price and liquidity. Mexico’s Circular Única de Casas de Bolsa, which contains the Comprehensive Review of Standard Operations (RINO), aims to significantly improve trading operations in line with international practices. It has introduced new order types, agility in price formation, and faster insertion and removal of orders to create an environment that is more conducive to program trading and algorithm-based operations. RINO has adopted standards for DMA trading and enables brokers to implement multiple pipes to the exchange.

In contrast, despite growing trading volumes, the capital markets in Chile have minimal reliance on technology. However, the exchange has now upgraded its electronic trading engine to accommodate increasing volumes resulting from new DMA and algorithmic flow. Fidessa has recently worked with Celfin Capital, one of the country’s leading investment banks, and as part of the Celfin deal Fidessa have building a direct electronic link to the Bolsa de Comércio de Santiago, a move that will help open up the market to more international investors.

The LATAM markets may have their own particular features, specific regulatory issues and cultural practices, but the increasing use of technology and automation will almost certainly follow the same trajectories seen in the more mature markets of North America, Europe and even Asia.

The technology imperative

Since technology takes such a central role in the development of wholesale markets, the rate of growth in the market value of trading technology is similarly expected to be significant in LATAM. A rise in the number of positions on the trading floor will almost certainly be accompanied by an increase in demand for platforms to facilitate the rapid implementation of electronic trading, coherent risk management, and distribution of market data.

But as the countries of LATAM take their place on the global trading stage and the pool of competitors gets broader and deeper, greater levels of sophistication will be required.

We can expect the internalization already seen in foreign markets to spread, and markets to fragment as they have elsewhere. Trading between countries and cross-listing will inevitably increase. Systems for powerful, resilient order management—which can handle inbound/outbound international order routing, seek out and hit appropriate liquidity, offer comprehensive algos and basket functionality upstream of the EMS, and aid compliance—will penetrate further into the market.

In addition, while an investment in technology will enable innovation as well as provide a platform for new strategies, it is also an indication to prospective buy-side clients that the sell-side firm is a well-run, well-regulated, and forward-thinking; a safe and trusted partner. As scrutiny from regulators increases hand-in-hand with more stringent risk management requirements, this is a critical factor.

It is also the foundation of the return-on-investment calculation that must accompany any investment in technology. The simple fact is that in Mexico, Chile and Brazil (the most advanced markets in LATAM), investment in sophisticated technology pays dividends in terms of the number and value of the customers it will attract.

Firms that can offer comprehensive functionality and a choice of algorithmic trading options, as well as the necessary membership to the appropriate venues are inevitably more attractive. Returns can be measured in the increased volume of trades being handled. In fact, it is possible to extend this idea and state that without the technology and the functionality it offers, simply participating in the markets will become more difficult by degree.

Vendors are now extending functionality to adhere to regional market requirements, incorporating local market data into their trading platforms, building local market gateways and providing tools enjoyed by counterparts in other regions such as Europe, Canada, Asia and the US. Innovative technology providers are working with firms in LATAM to develop systems to meet their needs, to facilitate electronic trading, and to ensure that technology plays its part in the development of capital markets. Costly and time-consuming in-house development of proprietary systems is no longer necessary. And so the question is no longer whether a firm can afford to invest in technology, but whether it can afford not to.

Alice Botis is head of business development, Latin America, at Fidessa