James Rundle: Prizing Open Markets

It was no surprise that Direct Edge, the third-largest stock exchange in the US, submitted a detailed response to a request from Brazilian regulator Comissão de Valores Mobiliários (CVM) for information and comment over the possibility of opening its exchange landscape to competition this month. Most US exchanges have been involved to some degree with the growing Latin American markets of late, such as NYSE Euronext’s joint venture with Americas Trading Group, or Nasdaq OMX’s technology provision to Bolsa Electrónica de Chile. The relative growth in recent years witnessed in the region, despite hiccups this year, and the geographical proximity to the US, make it easy to see why.

Brazil is the latest country to consider ending mono-dominance in its exchange ecosystem, following high-profile moves by countries such as Australia in doing so. The Antipodean nation offers a solid example of how to go about accomplishing this without introducing the gold rush and mass disruption that occurred in Europe with the introduction of the original Markets in Financial Instruments Directive (Mifid), and the Balkanization of the equities landscape as a result.

Complex Structures
CVM is attempting a thorough examination of how fragmenting its exchange system will affect the market, asking respondents to consider best execution concerns, market data distribution, and perhaps most pressing of all, self-regulatory obligations. Brazil currently operates a tripartite regulatory structure, with CVM overseeing the financial and capital space alongside the National Monetary Council and the Central Bank of Brazil, and the addition of more spokes to the wheel could provide overwrought complexity if not constructed carefully.

The Australian Securities and Investments Commission (ASIC) has adopted a piecemeal, regulate-as-you-go approach with the gradual introduction of rules regarding dark liquidity, high-frequency trading (HFT), market access and other areas. CVM, in its approach, appears to have identified these areas before the green light is given.

These moves aren’t likely to trouble Brazil’s BM&FBovespa. It has a decent degree of technological sophistication already, and agreements in place with institutions such as the Chicago Mercantile Exchange for order routing. However, new entrants to the venue landscape always introduce an element of technological upgrade and change. The moderate increase in Australian HFT levels after Chi-X opened its doors is testament to that, along with its massive increase in Europe as the traditional national exchanges lost their exclusive seat at the head of securities trading.

Giving access to alternative venues is a process that needs to be considered fully, lest it cause mass disruption.

Hard Wired
Underlining all of these technological improvements are necessary changes to the nuts and bolts of a country’s capabilities. The introduction of co-located facilities, datacenters, fiber optic and microwave networks, and high-performance computing require a significant level of capacity from local infrastructure, and the associated level of expertise from engineers to build and maintain it. If Brazil aims to compete on a level with other major markets, then this is a consideration.

On the compliance and oversight front, the introduction of high-technology strategies demands a degree of sophistication from regulators. European agencies were caught off-guard by the growth in algorithmic and high-frequency trading, which left them totally unprepared to deal with market developments as they occurred. Even the US, with arguably the most efficient and sophisticated markets in the world, has struggled to cope.

US equities exchanges will be keen to come on board if Brazil opens its markets, despite complaints about volatility and low levels of initial public offerings (IPOs) this year. But giving access to alternative venues is a process that needs to be considered fully, lest it cause mass disruption and decrease market efficiency, rather than the intended opposite effect.