By Dr. Christian J. Zimmer, Quantitative Research, Itaú Asset Management and Chair LatAm, FIX Community, and Leandro Pereira, IT Manager, Itaú Asset Management
Fixed income trading in Brazil is now much more efficient, and attention is moving to equity order matching and stock-lending.
Brazil witnessed significant advances in electronic fixed income trading in 2017. The country’s notoriously high inflation rates means fixed income is an especially important asset class in Brazil, so improvements in trading infrastructure and systems have a substantial and supportive impact on the country’s savings and investment industry.
However, electronification in the fixed income market historically always lagged a considerable way behind equities. There are several reasons for this, including fragmented liquidity, an entrenched human trading culture, buy-and-hold investment preferences and a requirement for pre-trade submission of cash and securities to meet T+0 settlement.
Progress was made following a FIX Community event in 2016, where representatives from the buy-side and sell-side in Brazil recognised that innovation was needed in the local fixed income markets. In particular, sell-side firms agreed to move towards electronic trading as long as the buy-side was supportive. A local FIX Protocol (FPL) committee decided in 2017 that it should focus on three major issues for enhancement. These were: fixed income electronic trading, intraday trade matching for equities, and stock lending.
At this time, fixed income securities were tradeable on the BM&FBovespa and Cetip (later merged into B3) and on a Bloomberg platform, fragmenting an already illiquid market in private and public debt. As Cetip was the most liquid market at this time, a pilot project between Itaú Asset Management (IAM) and Cetip was initiated to route fixed income orders.
Pilot project
So, an arrangement was made with Cetip, where IAM can route the orders to the market, such as send orders to the brokers in the market. Basically, there are three types of fixed income order:
• Market Order
The market order is the most traditional kind of trade, used by the entire market, in this kind of order the buy side sends the order to a broker indicating the limited price or limited yield (usually limited yield). This kind of order is defined by the value 0 (zero) at the tag #828.
• On behalf of
Orders on “behalf of” are similar to the above market orders, the only difference is the tag #448, where the buy side identifies the broker that will appear at the Cetip platform. This kind of order is used only when the buy side decided to create an order in a order book.
• Cross opportunity
This type of order is chosen when the seller and buyer are management desks of the same institution, trading the same security, but on opposite sides of the transaction.
In the Brazilian market the central bank doesn’t allow trades between two accounts without a broker intermediating the trade even for an internal crossing opportunity the buy-and the sell-order must be sent via a broker.
From the sell-side perspective, an order originated from an internal crossing opportunity is very different to a market order. The FIX message for this kind of order has special tags filled by the buy-side, in order to indicate to the sell-side the details of the trade as follow: #828: Trade Type: 3 (Cross opportunity). #548: Cross ID: Identifier for the cross order. (The ID is used to link the buy and sell orders, and only two orders can have the same ID per session).
One of the problematic workflows for the fixed income industry is in the post-trade process, because all trades must be registered with the central bank for T+1, and the cut off time is 7:00pm.
1. Allocation
Every trade scenario has a specific FIX message, but all orders are pre-allocated within FIX 4.4 using repeating groups with the tags #79 and #80. That was the practice for the market at the beginning of the project, but was abandoned without any major issues for the participants.
2. Settlement command
Due to a convention of the Brazilian market, the seller is responsible for the origination of a number (unique in the day) to be used in the settlement process at the central bank. This number is called “command”. In this project we used the custom tag #8000 in the repeating group, to accommodate the settlement command.
3. Settlement account
The settlement account is a number defined by the broker, and represents the agency or principal account to be used in the settlement process at the central bank. During this project we included this number in the custom tag #8001 and the broker provides that information for each order fill sent.
4.Validation
Since the post-trade validation is included during the trading process, the broker has to implement the following validation before acknowledging the message:
- Verify if all accounts indicated at the repeating group of the tag #79 are allowed by the brokerage.
- Verify if the security identifier of the tag #48 match with the other securities information in the message, that is maturity date and ticker.
- Verify if the yield of the order is fair, according to the spreads currently executed in the market.
Once the order is executed, the broker has to send the execution price for the order, even when a target yield was provided as a reference for the execution. This allows the buy-side to verify if the price is correct, corresponding to the yield provided.
The participating firms may then send the order to the central bank for registration, without any order post-trade process.
And what are the plans for the next few years? Although there is always place for improvement, we understand that the process for fixed income trading is now relatively well designed and effective. Now, it is time for the rest of the market to follow the trend and board the electronic trading train.
We believe that there is also a pressing need to improve the real-time matching of Brazilian equity trades, which is still a remarkably manual process.
Matching of equity trades in Brazil
The process for matching equity trades in Brazil is the following:
- When trades are completed – that is, after the market closes – the buy-side sends a flat file (a “tordist”) to the sell side. This file specifies how all trades made on the omnibus accounts should be distributed to the final accounts that trade under this umbrella.
- The Brazilian exchange, as the central counterparty clearing (CCP) for all equity trades, demands an allocation of all trades that are executed on a trade-by-trade level. This means that if an omnibus account sends one trade to the exchange and receives 10 fills, then 10 distributions must be indicated for each fund participating in the trade. So, if five funds participate in the trade, the buy-side sends 5*10=50 designations. It is not permissible to work on an average price basis.
- The sell-side receives the distribution and inserts it into a system of the exchange, called Sinacor. After processing all trades and distributions, the exchange “clears” all trades and thus allows the sell-side to close the day.
- When all trades and allocations are approved, the sell-side sends a confirmation file to the buy-side (“pesq”).
- If nothing is wrong, the buy-side matches the tordist-file with the pesq-file and then inserts the accepted allocation into the middle- and back-office systems.
This process is only for physical allocation: a separated file is sent from the sell-side to the buy-side with all the transaction data, and depending on the buy-side systems, these values are confirmed with the internally calculated result based on the physical allocation file.
Sometimes trade allocations do not match – perhaps because of an execution error – and maybe the error is only identified after the market has closed. This causes an end-of-day panic, putting pressure on trading desks and middle offices. But, creating a point-to-point FIX-allocation process is cumbersome and some players do not have the systems to post their information into a FIX engine.
Stock lending and borrowing
The liquidation part of the stock lending and borrowing process is easily automated, with APIs available from the CLBC (the exchange’s entity responsible for equity custody). Simple commands can be used to inform new borrowing and lending operations, renewals or cancelations.
For the buy-side, the problem is less in the operations aspect of executing a deal, but more on the deal-arrangement aspect and finding liquidity. A first step in the direction of creating a deal-arrangement platform is with the intraday price (rate) broadcasting of deals sent to the CBLC.
We hope that within the next year and a half, we will have devised a more efficient solution for equity trade matching, and also have found ways to improve and automate the stock lending process.
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