Andy Webb: What has BM&FBOVESPA's strategy been with respect to auto/algo trading?
Marcio Castro: It varies depending upon which part of the exchange we are talking about. The exchange as it stands today represents the result of a May 2008 merger between the BOVESPA stock exchange and the BM&F derivatives exchange. The two entities have followed slightly different policies with regard to matters such as high-frequency trading.
Andy Webb: In what respects?
Marcio Castro: On the BM&F side we launched direct market access in August 2008. Since then we have seen a substantial increase in DMA activity. In January 2009 it accounted for 3% of the exchange's average daily traded volume, by October it had reached 15.1% and for just the first three weeks of November 2009 it was 16%. This has gone hand in hand with an increase in high-frequency trading activity, which now represents some 6% of average daily traded volume on BM&F.
Andy Webb: Does BM&F have a policy for encouraging high-frequency trading?
Marcio Castro: We operate a discount policy for high- frequency trading, whereby accounts that are classified as high-frequency benefit from lower pricing. We use a variety of criteria when deciding whether to assign high-frequency status to an account. These include outright trading volume as well as the nature of the individual markets being traded. We don't have a fixed number that an account has to turn over in order to qualify as high-frequency.
Part of the process involves interviewing the market participant concerned about their trading strategy. We obviously do not expect them to disclose the exact details, but we are looking for some indicators as to the level of volume they are likely to transact and also the instruments they will trade. The greater the number of different instruments they are likely to trade, the more likely it is that we will designate the account high-frequency. After the account goes live we also monitor the level of activity on it in real time to ensure that it really is operating on what we would regard as a high-frequency basis.
Andy Webb: What contracts attract most high- frequency activity on BM&F?
Marcio Castro: FX and stock indices in particular and mini contracts in general; in terms of transaction count, high-frequency trading can account for about 50% of all activity in these contracts, even though the ticket size on these transactions will be relatively small. By contrast, interest rate contracts have seen comparatively little high-frequency activity so far, a situation we are looking to change.
Andy Webb: What about high-frequency trading on the BOVESPA segment of the exchange?
Marcio Castro: We don't have a discount policy for high-frequency trading on BOVESPA, but it nevertheless accounts for a significant portion of all trading activity. In October 2009, BOVESPA had 436,000 trades worth a total of BRL7.3bn; we estimate that DMA activity accounted for 40% of the total volume and high-frequency trading accounted for somewhere between 10% and 15%.
Andy Webb: Do you impose any limitations on high-frequency traders in terms of the ratio between their message volumes and completed trades?
Marcio Castro: Again, we deal with this differently on cash and derivatives segments, but are looking to harmonise our policy. On BM&F we don't apply any required ratios in terms of messages to completed orders. On BOVESPA we apply a threshold ratio of six to one; if this is exceeded, additional fees apply.
Our intention is to apply these thresholds on both segments of the market at some point in Q1 2010, but at a higher level than that currently applicable to BOVESPA. The objective is to achieve some discipline around message/order ratios, but without restricting high-frequency trading activity, which we are keen to increase on the BOVESPA segment of the market.
Andy Webb: Do you have any "hard" message limits to prevent disruption?
Marcio Castro: All our exchange gateways have message throttles that are activated if a particular FIX session reaches a certain number of messages per second. This prevents any individual participant disrupting trading by flooding the market with messages. We've had this functionality available for some time but have only recently activated it.
Andy Webb: Do you feel that the exchange's integrated cash/derivatives model has facilitated the growth in automated trading on BM&FBOVESPA?
Marcio Castro: Yes absolutely - we're seeing extensive use of this in terms of automated arbitrage strategies, which we are keen to facilitate. This sort of activity has been particularly apparent and beneficial in FX. For example, our clearing house clears both FX spot and futures. Historically, FX futures have been considerably more liquid than FX spot, but automated arbitrage activity between the two has had the effect of appreciably improving spot liquidity.
In addition, we have initiated exchange linkages that are proving popular with DMA users. The CME Group link is a case in point; our connection to Globex allows any BM&F participant simultaneous access to Globex contracts and vice versa.
Andy Webb: How are you harmonising the technology platforms of BM&FBOVESPA's cash and derivative segments?
Marcio Castro: We have been working on providing participants with a single interface so they will only require one FIX session for order entry and execution reporting on both the BOVESPA and BM&F segments. There will also be a single FIX market data platform for both market segments. All this is due to be available to market participants for testing early in the first quarter of 2010. The details of this have already been published and we are already working with participants to help them adapt and code to the new interface so that we will have critical mass when production testing starts. However, we will be maintaining the current infrastructure in the meantime and will make a progressive transition to the new interface before closing the existing interfaces.
Andy Webb: What operating systems and hardware does BM&FBOVESPA use for its trading platforms?
Marcio Castro: On the BOVESPA side we are using Red Hat Enterprise Linux and on the BM&F segment we use Microsoft Windows. Prior to the merger, both exchanges were moving in the direction of Windows and Intel. I think it is likely that we will continue to operate on a mixed operating system basis in the near term, but in the future I think we will probably migrate more in the direction of Linux.
On the hardware side, most services run on commodity Hewlett-Packard Proliant DL servers. We are currently migrating to the G6 version of the DL, which offers high-end processors. We noticed that the G6 hardware delivered robust performance for the type of workloads the exchange encounters, so we decided to migrate our server infrastructure in this direction.
On the internal networking side we are a Cisco shop for all our routers and switches. We use the Catalyst 6500 series switches and have been pleased with the performance. Most of our servers are currently connected to a 1Gbit network, but we are close to completing a switch over to a 10Gbit network.
Andy Webb: What is the exchange's strategy as regards emerging technology, such as Graphical Processing Units (GPUs)?
Marcio Castro: We've obviously been tracking developments in parallel processing, such as the use of GPUs through our research and development group. The group focuses on this and various other emerging technologies such as solid-state disks and the use of direct memory access.
However we are risk averse as regards anything that affects the reliability of the trading process, so we prefer to undertake exhaustive testing before implementing any new technology.
We prefer not to be the first adopters of new technology in order to minimise risk, but without falling behind the marketplace.
Andy Webb: What about the exchange's external connectivity?
Marcio Castro: Until very recently we were using just one network provided by a Telmex subsidiary called Primesys, which used MPLS technology and provided mostly local coverage. However, since June 2009 we have added another eight network carriers.
The additional providers offer a variety of technologies such as fibre, radial or Ethernet. As a result of adding them we obtained a net price reduction for market participants as well as greater bandwidth availability and speed. At the same time, this carrier expansion obviously opened up the market considerably to overseas participants. As a result, we have seen organisations across Asia, Europe and North America looking to connect to BM&FBOVESPA. It is still early days and much of the new technology is being adopted by local participants, but we are now definitely also seeing considerably increased interest from potential overseas participants.
Andy Webb: What connectivity options do you offer as regards DMA?
Marcio Castro: We are working on increasing distribution through a range of new exchange access methods, but at present we apply our DMA model in four distinct ways:
- Traditional DMA - the participant connects through a broker and the broker connects to the exchange.
- DMA via a DMA provider - the DMA provider (such as Bloomberg) connects its network to ours to offer client access. (This access method is currently live on BM&F and will soon also be live on BOVESPA.)
- Sponsored direct connection -- a market participant anywhere in the world can connect directly to the exchange if sponsored by a local broker who applies appropriate trading limits to the client connection.
- Exchange co-location services - these were launched in June 2009. To date, seventeen 42U rack units have been leased and ten more are under negotiation.
At present DMA options 2-4 are available on BM&F, but will shortly also be available on BOVESPA.
Andy Webb: Sponsored access has been subject to considerable criticism of late as regards systemic risk. How can you control your category 3 DMA to minimise this?
Marcio Castro: In addition to the message throttle I mentioned earlier on the technology side, we also have a trading limits throttle plug-in that is applied to each exchange gateway. This provides risk control on a pre- trade basis from the business perspective and operates on two levels. One level is controlled by the exchange where we can specify position, activity and ticket limits for each instrument for each FIX session; these exchange limits are set by BM&FBOVESPA's risk committee.
The second level is controlled by the sponsoring broker, who can establish limits for their client for individual instruments, classes of instruments or an entire group of instruments. The broker can only apply limits that are less than or equal to the exchange's limits. In addition, brokers receive drop copies of all category 3 and 4 DMA client trades.
Andy Webb: OK - but what controls do you have if an individual client's activity is inappropriate, but their broker has not established suitable broker level limits?
Marcio Castro: Because BM&FBOVESPA is both a diversified and vertically integrated exchange, we can monitor both trading and clearing activity. We can therefore trace risk all way through to the end beneficiary account level (unlike many other trading exchanges that can only trace to the broker level). The alerts that we maintain at this end beneficiary level are automatically distributed to brokers and clearing members.
This acts as a further backstop to brokers' own internal risk systems and is intended to forestall situations where a single broker client can cause more systemic damage, such as that caused by John Ho Park in the case of Griffin Trading.
Andy Webb: What are your expectations for your co-Location service?
Marcio Castro: It's still early days, though growth has been encouraging; in terms of average daily traded volume, clients using the co-location service traded 2500 contracts in August 2009, 7000 in September, 11,700 in October, and 16,300 in November.
However, we don't see co-location (which typically consists of high-frequency trading participants) as likely to dominate activity. A healthy market is one that has several classes of participant trading in differing styles on the same order book. For example, a pension fund will have very different trading behaviour to a retail investor or a financial institution or a corporation.
Ideally we want to see a balanced mix of all these categories of participant trading on the same order book, as we regard this as beneficial to all of them. For instance, a high-frequency trading co-location user typically deploys models that are systematic in nature and will always trade the same way given a particular set of circumstances. By contrast retail investors have more random trading patterns to their activity. These two styles actually complement each other when it comes to generating a balanced order book that facilitates trading for all participant categories. If high-frequency trading exceeds a certain level then those participants soon find there is nobody left to take the other side of their trades.
Andy Webb: Where do you see the exchange's growth as likely to originate in the future?
Marcio Castro: We anticipate that most growth will come from global participation rather than just domestic activity, which is why we have a strong focus on increasing distribution.
Other growth drivers we see are high-frequency trading activity (especially on the BOVESPA side of the market) and greater retail investor involvement.