Though Brazil’s central regulator has publicly supported competition and BM&FBovespa (BVMF) has courted electronic and high frequency trading, major potential stumbling blocks exist related to clearing and settlement.
Though Brazil’s central regulator has publicly supported competition and BM&FBovespa (BVMF) has courted electronic and high frequency trading, major potential stumbling blocks exist related to clearing and settlement.
Prior to the mid-1990’s, changes in the Brazilian payment, clearing and settlement systems were aimed at increasing the speed of financial transaction processing. Then, in 2002, the focus shifted to risk management. As a result of those reforms, Brazil now has a national payment system with features such as same day settlement of large-value funds transfers and securities clearing and settlement systems in relatively short cycles, real-time or T+1 for government securities. In addition, all clearing and settlement systems settle in central bank money and DvP is observed.
In terms of safety, Wagner Anacleto, COO of Cetip, the Brazilian post trade services group, says that services in the country are considered state of the art. Cetip provides an organised OTC market for fixed income securities and derivatives and is the largest CSD in Latin America .
He explains that a central counterparty (CCP) is used for most derivatives, stocks and interbank foreign exchange transactions and almost all OTC derivatives and securities transactions must be registered in a centralised system. Straight through processing is extensively used.
“There is a lot of investment in post trade in Brazil, that is one of the reasons why it is so difficult for new entrants to build the same type of solution we offer. The regulators want to have competition but do not want to downgrade the level of service,” he says. “If you look at it from the point of view of beneficial owners, it is hard to find any other country where you can settle a transaction on the same day.”
At the same time, the recent rapid growth of high speed trading has not had an impact on the fixed income market, Anacleto admits. Still, even in this space, trading infrastructures are being improved upon. Cetip is upgrading its electronic platform because they are anticipating that the fixed income market in Brazil will experience rapid growth and is soon set to announce a US-based partnership.
Underlining foreign interest in post trade services in the country, IntercontinentalExchange (ICE) bought a 12.5 per cent stake in the Group last year.
Competition conversation
The major challenge for new competitors, particularly in the equity market, is access to post trade services. Both Direct Edge and BATS have announced plans to enter Brazil’s market, but BVMF leadership has not given any indication that it would allow direct competitors access to its clearance and settlement system.
“Right now, new competitors need to build a post trade solution in order to have authorisation to enter the Brazilian market and there is a big discussion around this, it is not like in the US where DTCC offers services for any new entrants in the equity market. It is difficult time for players wanting to enter into the Brazilian market in a short period, for now they need to build their own infrastructure or they must go to BVMF and make some kind of agreement for clearing,” Anacleto says.
Although the Brazilian regulator, Comissão de Valores Mobiliários (CVM), is working on a new regulatory framework for CSDs, the focus is on segregating activities for custodians, CSDs, depositors and entities registering assets. It is not currently focused on making it mandatory to provide clearing for competitors. At the same time, CVM is looking into international recommendations for the best environment for the equity market and whether it is the right time to issue regulation to provide a facility for competitors.
“New entrants do not realise how complex the post trade environment is. For example, the transaction in the depositary must be allocated to the beneficial owner, it has to be done at this level for clearing purposes, outside of Brazil you clear the transaction in the name of the broker. Also, Brazil is very strongly regulated for clearing and depository services. Competitors need to go and look carefully at what is the regulation put in place,” says Anacleto.
In a recent report, Instinet remarks that the efforts to attract new market players may bear fruit in creating volume, but the critical component of clearing costs is likely to remain unaddressed in allowing true competition without enforced interoperability. Meanwhile, some equity market observers have noted that the back office system in Brazil has failed to keep up with the fast pace of trading resulting in hedging activity exposing investors to the market.
BVMF did not respond to requests for an interview for their clearing and settlement business in time for publication.
Australian experience
Some years ago the Australian regulator, the Australian Securities and Investments Commission (ASIC), started paving the way for competition in the equity trade execution space. This led the way for Chi-X Australia to enter the market in late 2011.
Commenting on the process, Rohan Delilkhan, general manager of business development for Clearing and Settlement at ASX Clearing Corporation, says regulators recognised that opening up to competition required an assessment against existing structures for the benefit of users.
“ASX has made a decision to facilitate cooperation and work with regulators and Chi-X. We have a vertically integrated exchange but we have moved to create a horizontal structure within so that we can provide services to customers of companies that are competing with us on other levels. We don’t want to be obstructing a potential benefit to our users, so we have structures, including legal structures in place on how best to achieve that,” he says.
From the perspective of countries facing the same challenges, Delilkhan notes that aside from the prohibitive costs associated with setting up a separate clearing house for competitors, such a strategy can also introduce systemic risk.
“The structure that is forming in Europe, which is essentially competitive interoperability, took a long time to achieve, there are enormous complications and substantial additional costs to clearing houses. They have to create a separate default fund to mutualise risk. Regulators are cautious about trying to achieve an appropriate structure. But what is driving that model in Europe is a unified single market objective but in Australia we already have that, we aren’t connecting to other markets under the same structures as in Europe. You have to ask, do the benefits [of setting up more clearing houses] outweigh the costs?
“We have indicated to regulators that we agree with the view that what is important is that the default fund and the collateral associated with Australian transactions remain in Australia so that systemic risk can be managed domestically and participants are not subject to an offshore-based regulator in a distressed market or crisis market situation,” he adds.
