Brazil wants the world to know about its domestic securities lending industry, which has seen a 30% hike in recent years. But infrastructure providers face a challenge to provide the right clearing process. Lynn Stronging Dodds reports on Brazil's central counterparties.
Changes are afoot in the Brazilian securities lending industry. Recently, the country’s first trade body, the Brazil Securities Lending Association (Brsla), was launched to raise the profile and understanding of Brazilian lending.
Greg Wagner, global head of prime services at Itaú BBA and BRSLA founder, says the main aims are to foster increased international awareness of the Brazil securities lending industry and to create a centralised forum where global players and local exchanges can swap ideas.
It also plans to speak with regulators and address some of the main challenges that face the industry. Wagner notes that there are around 15 generally common issues that get regularly flagged in conversations with international participants.
The overriding issue is the lack of liquidity on the Brazilian Clearing and Depository Corporation’s (CBLC) securities lending market. There are more Brazilian securities available for loan in the US through pension funds alone than all the shares outstanding in Brazil through the CBLC.
The reason behind this is mainly that all activity has to be executed through a central counterparty (CCP). The CCP’s job is to provide a guarantee to the securities lender that their stocks will be returned and all corporate actions delivered. However, this goes against the grain of some of the corporate charters of developed market funds.
There has also been limited competition in the country. The São Paulo-based BM&F Bovespa has enjoyed a near-monopoly since 2008, when the stock exchange group was created by a merger between the country’s Bovespa stock exchange and the BM&F futures exchange. It has operated four separate clearing houses, or CCPs, providing clearging services for equities and equity derivatives, financial and commodity derivatives, foreign exchange, and government securities.
Each CCP had its own systems and processes – meaning a dealer that cleared a broad spectrum of securities at BM&F Bovespa could face multiple margin calls each day, each calculated on a standalone basis.
In 2012, it announced a plan to combine all four clearing houses into a single, integrated CCP. It was supposed to be operating by the end of 2013 but has been delayed to give market participants more time to obtain training and certification for the new system. When completed though, it is expected to result in margin efficiencies of around 30-40%.
Improvements are also being made tothe stock exchange operator’s securities lending system, called BTC, including operational enhancements, product improvements, early return deadlines, recall settlement cycles and delivery failure treatments. In addition, there will be a range of new features such as statistics, average rate disclosure of one, three and 15 days and also a ranking of brokers by their loans outstanding.
Transparency should also be enhanced through a trading screen release of the order book and a standardised 30-day contract.
The integration of the BM&F Bovespa’s four CCPs will benefit the whole market, says David Rodrigues, head of sales and relationship management at BNP Paribas Securities Services in Brazil. “The four different clearing houses will have a harmonised set of rules and procedures. We have also heard about Americas Trading System Brasil (ATS Brasil) potentially launching a clearinghouse alongside a new stock exchange but it is too early to tell the impact it will have on securities lending.
“However, I don’t expect the securities lending model to change, though, and think that all activity will continue to be through a CCP.”
Chris Holzwarth, head of global sales and relationship management for securities finance at State Street Global Advisors, also believes it is early days. “We have been looking at the Brazilian market and its unique CCP structure and hope to be lending Brazilian equities in the very near future. All loans of Brazilian equities have to be made through the BM&F Bovespa. That being said, the planned launch of ATS Brasil in late 2014 as that country’s second stock exchange is certainly interesting.”
If ATS Brasil were to compete with BM&F Bovespa’s CCP it could be a double-edged sword. On one hand, the additional supply could reduce today’s attractive spreads, but on the other hand the competition would likely lead to reduced fees, costs and penalties in the marketplace. “We’ll have to wait and see.”
ATS Brasil, which is a joint-venture between Rio de Janeiro-based trading systems operator Americas Trading Group (ATG) and NYSE Euronext, now owned by IntercontinentalExchange (ICE), filed to become an exchange with the Brazilian regulator CVM in June 2013. It expects regulatory approval to be granted in February and the launch date is set for next November. The opening is planned to coincide with a new Brazil-based clearing house being formed by ATG, which has an 80% stake in ATS Brasil.
The aim is to capture a 15% market share in Brazilian equities trading within two years of operating, and then enter the corporate listings business. It may move into the derivatives space in the future but the main focus will be to aggressively lower trading costs, which are on average 15 times higher in Brazil than in other major markets.
If successful, ATS Brasil will be the first competitor to BM&F Bovespa. Others have tried. In February 2011, BATS announced it was considering the possibility of entering the Brazilian market in partnership with Claritas, a local asset manager. In November that year, Direct Edge said it had plans to set up an electronic equities trading platform in Rio de Janeiro by the fourth quarter of 2012.
Progress has been slow because of difficulties with clearing trades in the country. The rule in Brazil is that if another exchange wants to enter it must be vertically integrated with a CCP, but establishing a CCP is not only time consuming but also capital intensive and expensive, according to Rodrigues. “I am interested to see if ATS Brazil will implement a new CCP. At the moment, BM&F Bovespa has said it would potentially allow other firms to rent out its post-trading once the bourse has finished integrating its four clearing houses, which is not expected until the beginning of 2015.”
ATS Brasil had initially planned on using BM&F Bovespa’s services, but after conducting due diligence concluded there was an opportunity to create a plain vanilla facility that only clears cash equities and exchange-traded products.
With no margining involved, the firm believes the clearing house will cost just 150 million Brazilian reals ($65 million), including mandatory capital, spending on systems, and the starting of the business.
ATG was expecting to file the application for the new clearinghouse, and to announce a consortium of backers for the project in mid-December.
The group is expected to include ATG, Brazilian risk consultant Risk Office, as well as one major Brazilian commercial bank and one clearing house operator - either ICE, LCH.Clearnet, which is majority-owned by the London Stock Exchange Group, or Clearstream, owned by Deutsche Boerse.
“There are new CCPs trying to establish businesses all around the world but it is a struggle to get things off the ground,” says David Little, director of business and strategy at technology consultancy Calypso. “The big question is whether they will attract significant liquidity,”
In the meantime, market participants are adopting a wait-and-see attitude in terms of the effect these new development will have on the country’s securities lending industry.
Brazil has seen a 30% hike in activity over the past four years, which places it ahead of ahead of Taiwan and Korea which are similar in size and volume. Industry estimates show that the country’s market capitalisation is $1,000 billion with average daily traded volume at around $4 billion. Liquidity is still an issue though and it remains to be seen as to whether the new BRSLA can help improve the situation.
“I think the securities lending industry has developed well and there is a large proportion of foreign investors that do play an important role,” says Rodrigues.
“However, in Brazil, we a have a CCP model rather than a bilateral one where, according to some funds’ bylaw, portfolio managers are not allowed to concentrate 100% of risk with one sole counterpart and they do need to have the ability to choose collateral, which is not so straight forward in a CCP model so far.”
©2013 funds global latam