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Brazil - The Challenges of DMA and Risk Management

Published in Automated Trader Magazine Issue 25 Q2 2012

As the Brazilian economic freight train gathers momentum, Timo Pentner - Managing Director Americas, at RTS Realtime Systems, explains why the market's demand for ultra-low latency DMA access and the regulators requirements for rigorous risk control don't have to be mutually exclusive.

Timo Pentner

Timo Pentner

Managing Director Americas, at RTS Realtime Systems

With US and European economies still wrestling with deeply entrenched structural economic problems resulting in largely stagnant economies, investors have been looking further afield for investment returns. One of the markets that has attracted significant foreign investment is Brazil, and it's not too hard to see why. Brazil is rich in mineral and energy reserves with oil, gas, hydro-electricity, bioethanol and uranium; agriculture is booming with Brazil now boasting the world's largest cattle herds, and as well as the exports of commodities long associated with the country such as coffee and cocoa, Brazil now produces the majority of the world's exotic fruit. On the back of these strong fundamentals, Brazil has experienced rapid growth in its middle class amongst the growing population of 200 million. Economic output has now overtaken that of the UK and its broad IBRX market index, despite strong volatility, has grown by over 60% since the financial crisis erupted back in 2007.

With this foundation in place and strong inward investment, it's easy to see why Brazil has attracted such considerable interest from the global trading community. We noted with some interest some of the statistics about Latin American growth from Automated Trader's recent algorithmic trading survey; the key point being that within three years the number of buy side firms accessing LatAm markets is expected to quadruple, with Brazil being probably the best placed to capitalize on that interest. A significant factor behind this growth is the innovation now being demonstrated by Brazilian markets.

The Brazilian exchange BM&F Bovespa illustrate this point well, with recent innovations including single stock options, interest rate derivatives, clearing house cross margining, and a new low latency multi-asset-class matching engine with co-location options, called Puma. Now a cross-listing and cross-licensing deal with CME Group and S&P Indices has been launched meaning that Bovespa index products will be available in Chicago for dollar clearing, while S&P 500 futures, CBOT Mini-sized soybean futures and NYMEX listed light sweet crude (WTI) futures will all be traded in São Paulo with settlement in Brazilian Real. Little wonder then that traders are rushing to get past capital controls or that regulators mindful of earlier Latin American misfortunes, are keeping a close, prudential eye on market risks.

With the objective of addressing these issues, RTS Realtime Systems have been working hard to deliver ultra low-latency connectivity and risk solutions to trading firms looking to access Brazilian markets. High frequency traders will now be able to trade Brazilian markets with fully compliant pre-trade risk checks. US based traders will be able to co-locate in the exchange's DMA facility for sub millisecond access, slashing latencies available to US based order routing networks and substantially outperforming current third party colocation options in Brazil. The mandatory risk checks can be independently monitored and controlled in real time both by the executing local broker in Brazil and for example by the trader's own US based clearing broker, while ensuring a dependable, pass-through latency in tens of microseconds. When combined with a growing number of long-haul optical fibre networks, cross-market and cross-region arbitrage strategies become real opportunities.

Both the clearing broker and the executing broker will specify their own risk checks and each will be able to modify their limits or other parameters independently in real time. Meanwhile RTS will ensure risk checks comply with the exchange's own rules and provide verifiable and consistent trade data to all concerned. As a result, costly reconciliation and remote monitoring can thus be avoided. This reduces risks for the whole supply chain. Remote US traders have had to put up with the uncertainties of long haul networks and considerable jitter depending on overall trading volumes. Since initial margin rules are tough with daily adjustments, traders are keen to keep tight control on their positions. The RTS direct market access (DMA) option reduces these exposures of remote trading, allowing strategies to be more adventurous and demanding.

The RTS Brazilian solution effectively opens a new generation of multi-institutional workflow for integrated collaboration in the capital markets. By packaging all the risk checks in a single software application supporting both FIX and the local exchange application programming interfaces (API), we have responded to the messy realities of cross-jurisdictional trading and longer supply chains, and we've taken a lot of cost out of the equation as well. RTS is already working with a number of local and international brokers including Ativa, SLW, Alpes and ICAP Brazil to leverage the new technology for international trading firms.

Currently virtually all trading is concentrated on the primary exchange in Brazil although several automated trading platforms like Direct Edge and BATS Global Markets have expressed interest and are in discussions with the regulators. The Intercontinental Exchange (ICE) has however launched its own electric power market and Chi-X Global has partnered with BM&F Bovespa to offer multicurrency trading in Brazilian securities, so change is coming. Additional competition will inevitably grow the Latin American markets and encourage high frequency trading to align price discovery. Liquidity, after all, follows liquidity.