Automated and algorithmic trading in Brazil can be conveniently dated back to the mid-2007 IPOs of the Brazilian derivatives (BM&F) and equity (BOVESPA) exchanges, and BM&F's subsequent partnership deal with CME Group. BM&F and BOVESPA merged to form BM&FBOVESPA (The New Exchange; see www.bmfbovespa.com.br).
Speaking in a personal capacity, BM&FBOVESPA's Mauricio Leventer says: "Since then, there has been steady progress in the right direction. The New Exchange is investing in high quality technology so as to ensure the continued delivery of reliable service to market participants, even under the highest volume conditions. We also see major Brazilian institutions making similar investments."
Automated Trader spoke to a range of market participants in Brazil, to gauge the take-up of automated and algorithmic trading in the first of the BRIC economies. The story is told in the participants' own words.
Please outline your firm's take-up of algorithmic and automated trading functionality.
Christian J Zimmer, Banco Itau Our brokerage division is pushing automated trading either with in-house solutions or third-party software. The asset management division is the first in Brazil to implement the Charles-River system. This will have a huge impact on how trading is made at Banco Itaú (and nearly all other market participants): today, execution and post-trade is manual and via telephone. The division I work in is responsible for quantitative research and trading. Because of the nature of this business we developed our own trading and asset management system (AAS - Automated Allocation System). It is an event-based distributed system running on a Beowulf Windows grid, although we aim to include some dedicated clusters, too. The development was 100% in-house. We did not focus on automated execution but more on quantitative trading, what we define as being the model-based decision-making for taking a market position and attributing trading margin to the strategies.
Francisco Valente, Agora A few years ago, while analyzing the institutional environment in more developed markets we noticed the strong presence of electronic trading platforms and the heavy use of algorithmic trading models. By that time, we realized that at some point in the future, our market participants would start demanding quantitative models for order routing, so we have created an area dedicated to research and develop algorithms for the Brazilian Market. We started equipping our internal trading desk with algos focused on transactional cost reduction, like VWAP, Volume Participation, Pairs Trading, Volatility Arbitrage, among others. Subsequently, it was a natural path to begin providing them to our final clients and the demand is getting bigger every day.
Carlos Nobrega, EconoFinance The company began its activities at PUC-Rio, a top University in Brazil. Our computer analysts, most of them with a Masters or PhD degree, developed very sophisticated on-demand software for some top companies, building a bridge between academic knowledge and industry needs; this is still our focus.
In July 2006, we started with the development of software for risk management for a large pension fund in Brazil. In the following year, 2007, we became totally independent from PUC-Rio and started to build contacts with stock brokers. Currently we develop our software solutions exclusively for the sell side. Then the broker offers our software solution to their clients - investment banks, assets, et cetera -so that they can customize their proprietary strategies easily and directly execute the orders based on the concept of co-location. Co-location in Brazil is quite different from co-location in the US or UK due to restrictions from BOVESPA and BM&F.
Our clients are some of the largest national and international market players and we want to help them grow in the Brazilian market. So we can say that our software is an execution system adapted to the reality of the Brazilian markets.
Alberto Araujo, Kairos Asset Management Nowadays we use a simple automated trading system to send orders to multiple exchanges worldwide (US, Mexico, Europe and Brazil) enabling us to find cross-border arbitrage opportunities. As the markets have become more efficient, requiring faster trading analysis and order-entry capabilities, we have started a proof of concept (POC) of a new system based on a Complex Event Processor (CEP).
We believe the implementation of CEP will allow us to capture the cross-border arbitrage opportunities in a faster and more reliable way increasing the number of instruments we can analyze and trade simultaneously. This feature is crucial for our core strategy and in the near future we will be working with foreign and local brokers to find the best technological solution to access the numerous exchanges where we can apply the arbitrage strategies in a more efficient way.
Hamilton Araujo, Planner Corretora de Valores By now, with the recent and growing importance of automated trading in the Brazilian market, we're assessing algorithmic and auto trading platforms with some local and recognized international vendors for off-the-shelf solutions. Since we basically act as brokers - Planner is a registered broker-dealer for the BOVESPA and BM&F exchanges - the idea is to have algorithmic tools to provide clients with high quality services of execution in a timely and precise way. This differentiation is extremely important to keep up competitiveness in the current financial services industry in Brazil and to be open to the internationalization of our markets.
Hellinton Takada, Itau Holding The ideas expressed in all my answers represent mostly the asset management point of view. After spending some time planning the architecture and deciding between in-house or outsourced system developments, our team selected a hybrid solution for the automation of our quantitative fund. Basically, we are developing a complex event processor framework to integrate several trading strategies. These quantitative strategies employ algorithms to search the market for opportunities and are event-driven. Additionally, the orders generation from strategies and execution management algorithms are almost accomplished. Now, we are just waiting for the local stock exchange integration and direct market access.
Will this continue, and perhaps accelerate? How has it changed, or will it change, the configuration of your trading function?
Christian J Zimmer, Banco Itau The execution part of the business is already under significant change. I estimate that in the next 5 years the market will change from 99% telephone trading to perhaps 50% (or less) as most of the big broker firms install electronic trading platforms at their clients, as well as trading networks like Marco Polo enter the market. It was a milestone when BM&F introduced electronic trading and pushed their new FIX platform. The fusion with Bovespa is helping to further accelerate changes in the next few years.
Our trading function will probably change little, as we consider ourselves as one of the market leaders in quantitative trading. We have a 7-person team (which is big for the Brazilian market, with 5 having top-university PhDs) focused on strategies for the local market and our experience in Brazilian quantitative strategies is up to 12 years. I estimate that we will enter into more diversified trades with increasing liquidity and advanced technology. A greater internationalization of the market will allow us to implement a wider range of cross-asset trades, but current regulation (esp. income tax) does not allow our funds to take advantage of the international market. The recently announced cooperation of BM&F and CME is seen as an important milestone for progress.
Francisco Valente, Agora We see it as an irrevocable trend and we believe it will accelerate sharply. It modifies our trading function as the buyside gets more control of their trades while the brokerage firms focus their efforts in guaranteeing the best execution.
Carlos Nobrega, EconoFinance In Brazil we are seeing a transition towards the full automation of market transactions. Compared with North American or European markets, algo-trading is still insignificant. However, there is a great interest in the theme and we do believe that it will grow very quickly over the next years. In fact the demand is huge. However we encounter certain difficulties in engaging competent analysts. Qualified people are scarce, because of this, we decided to restrict our partnership to less than half a dozen customers: two in the institutional market and two or three in the home broker market. Even so our productive capacity is already contracted until 2010.
Alberto Araujo, Kairos Asset Management The use of algorithmic and automated trading in our company is constantly in an upward trend. The Kairos Asset Management team is involved in seeking new strategies applied through automated algotrading systems, especially those strategies/systems that allow a lower ratio of trader per strategy or instruments, maximizing the use of our trading capabilities yielding a higher profit per human resources ratio. Based on that, we believe the implementation of algorithmic and automated trading solutions is still in an inception period. Both sides of the financial market (money managers and exchanges/broker dealers), especially in the Latin America Financial Market, will have to evolve in a new era of trading where more robust IT hardware/software/network will be required. This trading evolution will also require better trained market participants to handle higher numbers of transactions, to apply new regulations that come with new ways of trading which will certainly modify exchange risk and system crash controls.
Hamilton Araujo, Planner Corretora de Valores As we see the movement in the Brazilian market demanding more automation of trading, I'd say that we're surfing the first wave of the initial trend, which means a lot of international vendors coming down to Brazil to establish offices and hiring people to support their systems. After this initial movement, some vendors will be running behind and there will be the consolidation of this type of service in Brazil.
Hellinton Takada, Itau Holding In Wall Street, automation and new technologies have changed the trading game dramatically in the last years. Since the process is very recent in Brazil and the interest in smarter and more efficient execution seems to be increasing, I hope it will accelerate. Obviously, all these changes will definitely alter the trading function.
To what extent (if at all) has electronic trading determined/altered your company's overall trading strategy?
Alberto Araujo (right) with Gustavo Jacob
Christian J Zimmer, Banco Itau I would say that our brokerage arm may have felt the biggest impact as the clients' demands changed and are still changing. The existence of our quantitative hedge fund indicates that executive management continues to bet on our expertise, but the decision was not based on electronic trading possibilities, as some trades are low-frequency and may be executed by telephone if necessary.
Francisco Valente, Agora The major difference we have observed with the increased use of electronic trading is organic volume growth. It started on our trading desk, which was able to support much higher volumes and more complex trades without any increase in headcount and then extended to direct market access, allowing our clients to execute and monitor their own trading strategies in a very scalable way.
Carlos Nobrega, EconoFinance As we mentioned previously, we started building software for risk management. It was the demand for top programmers for electronic trading that prompted us to move in that direction. It is also important to note that Brazil is one of the top financial markets in the world and that the economy is growing way above the average. Those two factors created a huge demand for electronic trading.
Alberto Araujo, Kairos Asset Management Electronic trading altered the essence of the daily trading routine in our company. Trading volumes are much higher compared to a few years ago - the physical limitations then of verbal orders in terms of speed (and exhaustion) were restricting volumes - and that is obviously not the case with the new click and trade approach. Control systems (such as risk management, trade settlements, and account reconciliation) receive the information rapidly and reliably direct from the original source (exchange or broker-dealer) thereby avoiding the communication errors that were common in the past.
Hamilton Araujo, Planner Corretora de Valores Electronic trading in Brazil, which has taken longer to develop than in mature markets such as US and Europe, has significantly increased lately. A major factor in this expansion has been the growing percentage of the stock exchange's trading volume attributable to retail investors (24% as of Aug 2008). (The greatest percentage of volume is attributable to foreign investors - almost 35% as of Aug 2008). This shift in demographic has triggered increasing investment aimed at the retail market by what we call in Brazil the "homebrokers", which are web-based trading platforms specifically designed for this market segment. By the same token, to accommodate overseas investors, we've made a massive investment in order routing for foreign institutional investors globally, using the FIX protocol.
Hellinton Takada, Itau Holding Automated trading is now an integral part of our company's business continuity plan. Quantitative strategies and execution algorithms have now also become indispensable tools for traders looking for competitive advantage. In addition, the increasing volume of orders and the need to minimize latency require top flight technology to ensure the success of a trading strategy. That requires substantial investment, so the company's overall trading strategy has to change in order to accommodate this.
To what extent is the take-up of such functionality changing the trading environment in Brazil?
Christian J Zimmer, Banco Itau With easier electronic access to BM&F (and also, the integration with the CME) we expect to see increased trade from foreign firms with electronic trading know-how. This will probably push Brazilian firms into making a bigger investment in electronic trading. The market for quantitative funds is still small and is also restricted by the lack of suitably skilled local personnel. I think that Brazilian firms will survive as long as they can leverage their local market knowledge effectively, but this advantage is unlikely to persist for too much longer.
Francisco Valente, Agora The increase in electronic and algorithmic trading is changing both the market's macro- and microstructure. In the case of macrostructure we see strong volume growth, the interconnectivity of different trading venues across the globe and more arbitrage opportunities. In the case of microstructure we notice a reduction in the bid/ask spread and average tick size and an increase in the number of orders sent.
Carlos Nobrega, EconoFinance Fewer than 5% of the transactions in Brazilian markets involve the use of algorithmic trading software but we believe that by 2010 such software will account for more than 50% of transaction volume. That would represent a far greater and faster change in the trading environment than any other country has seen to date.
Alberto Araujo, Kairos Asset Management Brazil is experiencing a new and challenging stage in the evolution of electronic trading. Most investment banks and asset managers are racing the clock to establish the necessary IT structure for implementing algorithmic trading. This situation represents an enormous business opportunity for global software houses, as local software companies still lack the sophistication required to offer live exchange connections that are sufficiently fast and reliable to support algorithmic execution systems.
The merger of the two principal exchanges (BOVESPA and BM&F) and the partnership of the newly merged BM&FBOVESPA exchange with CME poses a considerable connectivity challenge. Connecting exchange and end users' trading platforms to allow investors from around the globe to access Brazilian markets will not be a trivial task. Some new regulations will also have to be put in place in order to allow Brazilian investors to reach the US and other foreign markets through the CME.
Hamilton Araujo, Planner Corretora de Valores Brazilian brokers are looking after their market share and trying to focus on retail and foreign investors.
Hellinton Takada, Itau Holding The development of electronic trading in Brazil is very recent. In Brazil, there is a lack of understanding of electronic trading systems, no availability of DMA and minimal use of execution algorithms. Consequently, the buyside is postponing the adoption of electronic systems for order routing. However, motivated by market competition, the most important sellside firms are investing in developing or acquiring the necessary technology and infrastructure.
For which asset classes do you use algorithmic and automated trading? For what purposes?
Christian J Zimmer, Banco Itau Our quantitative hedge fund uses models for the entire trading process. We do not use execution algorithms (VWAP etc) as we currently do not encounter liquidity problems. As yet, we have not decided whether or not to buy third-party execution algorithms if we enter markets where liquidity becomes a concern. The markets we operate in today are interest rate, FX and stock index futures, and cash stocks. Our main fund, QuantIB, is a multi strategy hedge fund that uses both relative value and directional strategies, but we intend to create and commercialize more specialized products in the next few years. All strategies are and will continue to be purely quantitative.
Francisco Valente, Agora Our Algorithm Team has developed algorithms for stocks, options, futures and combinations of these. We are mainly focused on developing algorithms that target transaction cost reduction and seek out best execution, using deterministic models based on price, volume and time. Nevertheless, we have also researched and developed decision-making algorithms that use prediction models to run statistical arbitrage strategies.
Carlos Nobrega, EconoFinance Buying/selling stocks, derivatives and commodities.
Alberto Araujo, Kairos Asset Management We use algorithmic and automated trading in order to find arbitrage opportunities that can be captured from cross-border markets, such as stock pair trading arbitrage, ETFs versus component arbitrage, futures calendar spread arbitrage and index arbitrage.
Hellinton Takada, Itau Holding We are still awaiting sellside integration with BM&F (mainly for futures), the implementation of FIX availability for DMA and BOVESPA (mainly for equities). However, faster progress is being made in these areas as a result of the BM&F and BOVESPA merger. By the middle of the next year, we hope to use electronic trading for the BM&F. We are also waiting for the relationship between BM&F and CME to enable cost-effective trading of futures on the CME.
What lessons, if any, do you draw from the US/European electronic trading experience?
Christian J Zimmer, Banco Itau We have not derived any particular insights from the US/European experience. However, we have observed the continuous race for low latency and processing performance and this has made us consider how we might compete with major international firms in this space.
We decided to develop our specialist knowledge in modelling and in-depth market understanding. We use a very rigorous research approach when implementing a new strategy. Our models may take years to develop and we often find ourselves having to resolve undocumented theoretical problems in order to create an acceptable trading approach. Ultra-high frequency trading with very large turnover is unlikely to become the main part of our business, but we will continue to use electronic trading to facilitate our daily operations.
Francisco Valente, Agora In developing our approach to algorithmic trading we have drawn upon our observations of foreign markets and the demands of our clients. We started developing our own algorithms and handing them to our clients, who have used them with considerable success. In fact, their comfort levels are now such that they have started developing algorithms themselves. As part of this process we have had a lot of client demand for assistance in customizing their existing proprietary models and creating new tailor-made models.
Carlos Nobrega, EconoFinance Some of our analysts have worked in European and American markets so we are aware of some of the mistakes that have been made elsewhere. For example, we have noted the problems that occur when too many execution models are competing for liquidity at a combined level that exceeds the available capacity of the market.
Alberto Araujo, Kairos Asset Management We usually take advantage of the prior US/European electronic trading experience as a benchmark that can be applied in Latin American markets (mostly Brazil and Mexico). US/European markets have tighter spreads and higher volumes than Latin American markets, which makes them useful environments for testing new high frequency trading strategies.
Hamilton Araujo, Planner Corretora de Valores Prior to joining Planner at the beginning of this year, I worked for five years at an American introducing broker. The main lesson I took from the US market was to use the FIX protocol as a standard tool for integrating our market to the global market community. The evolution of our market in catching up with mature markets, includes increasing volume due to electronic and automated and algorithmic trading, and greater consolidation of our exchanges so their infrastructure can accommodate this new reality. At present there is no statistical study of Brazilian markets that establishes the percentage of automated trading, but I believe it should be something between 5 and 10% of total volume.
Hellinton Takada, Itau Holding From US/Europe electronic trading experience it is clear that the advantages of adopting electronic trading - fewer errors, real-time notification of executions, reduced costs of trading and increased volumes - justify the effort and investment required. Additionally, another important lesson learnt is that to outdo the competitors, traders must use not only more sophisticated execution algorithms but also complex and advanced quantitative tools to support their decisions.
Does electronic trading simplify, complicate or otherwise alter the oversight process and management of risk?
Christian J Zimmer, Banco Itau At present, it is hard to make any observation as electronic trading is not widely implemented among the big banks. But, taking recent events into consideration, I would say that it will help to better integrate the front-, middle- and back-office systems, permitting a faster (perhaps one day real time) overall risk assessment.
Francisco Valente, Agora Once the adoption of algorithmic trading is firmly established, risk managers will need to move toward intraday real-time measurement in order to guarantee the control of intraday positional risk arising from proprietary trading models. Pre and post trade analysis is of ever-increasing importance in the local market.
Apart from that, the rising volume of order flow means that there is a greater demand for robust risk systems with large-scale processing capacity.
Carlos Nobrega, EconoFinance Since electronic trading can help to increase the frequency of transactions, the time that investors have to keep their positions can be reduced (time is inversely proportional to frequency). Supposing that part of the risk comes from invested time we can conclude that the reduction of time implies a reduction of risk.
Alberto Araujo, Kairos Asset Management We understand that electronic trading simplifies the whole trading process, allowing the oversight process to be on-line and accurate, as all the trade fills are received instantly and electronically (through FIX drop copies) which makes the management of risk, middle-office and back-office routines extremely fast and reliable. Nowadays we save a lot of staff time avoiding instruction and settlement errors that were common in the past when the systems were not fed by the electronic trading platform, but manually by traders.
Hamilton Araujo, Planner Corretora de Valores We have increased the number of people in the company involved in risk oversight. These personnel work closely with management to implement suitable margin limits for leveraged positions. Electronic trading depends heavily on reliable integrated risk management policies and systems for smooth operation.
Hellinton Takada, Itau Holding In the first instance, it complicates the management of operational risk. The major components of the legacy systems that handle risk management and compliance are not yet ready for integration with execution management systems. Nor are they capable of handling the high trade volumes that result from algorithmic execution. However, after these issues are resolved, electronic trading will reduce costs and error rates.