Aiming High

Ask any number of players in the Mexican capital markets how they would describe Jorge Alegría and you are likely to hear that the CEO of the Mexican Derivatives Exchange (MexDer) is “proactive” when it comes to attracting high-frequency traders. He is eager to espouse the virtues of trading on his exchange, the derivatives arm of the Mexican exchange operator, Bolsa Mexicana de Valores, (BMV). He also seems to understand the need for technology as a driver for growth.

But despite the exchange’s technological advancements, it hasn’t seen the volume flows of its Brazilian counterpart. Many have an opinion on how to fix this problem, but ultimately, the technology groundwork that has been laid is a clear sign that MexDer’s brain trust has a plan. 

Over the past four-plus years, MexDer has made significant strides in upgrading its hardware. In 2006, Mexico introduced the FIX messaging protocol, which supported the participation of remote members, with Greenwich, Conn.-based interactive brokerage firm Timber Hill being the first, according to Alegría. That was expanded upon this year with the introduction of the FIX interface.

Last year, MexDer partnered with Real-Time Systems (RTS) and installed new front-end trading systems for all Mexican members. International members already had the screens, Alegría says. This provided local clients with sophisticated tools with which to trade. Earlier this year, the exchange began offering co-location services for equities and derivatives trading. Additionally, Chicago Mercantile Exchange (CME) operator CME Group announced in March that it would partner with MexDer to allow derivatives routing services to BMV through CME Group, and BMV would be the exclusive exchange provider of derivatives order routing services to CME Group in Mexico.

This will allow “international investors [to have] easier access into MexDer [and] will improve liquidity and develop the local market ... [and] provide Mexican investors with more tools to manage their portfolios,” says BMV executive chairman and CEO Luis Tellez, in a statement.

Liquid Troubles

It is not technology holding Mexico back in its friendly rivalry with Brazil. Dan Watkins, president of consultancy CC-Speed, which is contracted by Latin American exchange trading services provider CMA in the US, says that in many ways, Mexico is ahead of Brazil in terms of technology and regulations, and firms can even save on costs by trading in Mexico. But while Brazil may have a higher price tag, it adds value and volume, which is something Mexico currently lacks.

“From a technology perspective, MexDer is probably a lot farther ahead than [Brazilian exchange] BM&F­Bovespa, believe it or not,” Watkins says. “In operating on its own, it has been deploying proximity solutions for at least a year now, and has been providing FIX connectivity for market messages, as well as trading and clearing for maybe three or four years.”

Martin Koopman, consultant at Aditat, recently compiled an extensive study of Latin America’s electronic trading landscape. While BMV is the second largest in region, it lags well behind BM&FBovespa. On the derivatives side, MexDer, which traditionally has more volume than the BMV, trailed BM&FBovespa by nearly 300 million contracts traded in 2009, according to Koopman. 

Like Watkins, Koopman says the problem is not technology. The problem is a lack of liquidity—hence the need to attract foreign high-frequency traders. While many of the local participants aren’t sophisticated enough for this brand of trading, it helps to bring liquidity to the market. 

“They really see the high-frequency crowd as a way to get around their liquidity problem,” Koopman says. “Liquidity is the only thing holding Mexico back.”

The moves the exchange has made are designed to attract high-frequency traders. In recent months, interest from high-frequency traders in the US and Brazil has picked up. It is not the technology that lags behind, Alegría says, but rather, it is more a matter of market sophistication.

“We have a very competitive environment in terms of technology. More importantly, our products are approved by the US Commodity Futures Trading Commission (CFTC), there is no withholding of taxes in Mexico, and we allow the margins in options and derivatives trading that international players can deposit in US dollars and US treasuries, which is not available in many markets, including Brazil,” Alegría says. “But what we need is a little more depth in the local market. We need not only international players to come in—we need local activity that we don’t currently have. When you compare us with Brazil, what Brazil has is a very active local investor base.”

The FIX(es)

Local investment is dominated by the pension fund community. Many of the restrictions around these funds, called Afores, have been lifted in recent years. According to an April 22 article from Reuters, Mexico pensions to invest $1 bln in new sectors, private pension funds will invest more than $1 billion as these once-cautious funds begin to take on more risk. Equity funds are primed to be the big winners.

The key to bringing this capital into MexDer will be getting the pension sector comfortable with using derivatives and over-the-counter (OTC) products, says Eduardo Navarro, managing director for markets and securities vending at Accival, the brokerage unit of Banamex, owned by Citi. The pension community has largely ignored these instruments, but flush with a capital infusion, that could very well change.

“For the local standards, we have a decent infrastructure and platform, but we have to work on getting these types of [pension] customers to know the derivatives products as well as the retail ones,” Navarro says. “But the technology that we have here can compete with almost every emerging market in terms of the FIX protocol, algorithmic trading, trading rules and the way data is sent to all the users. We are in good shape.”

Giles Nelson, chief technology strategist for Progress Software, which provides its cash-equity algorithmic trading platform to Accival, says Mexico’s volume problem has more to do with the nation’s close relationship with the US. Because of the macro-economic ties between the US and Mexico, many Mexican companies that want to attract investment from the US will put a listing, or at least an American Depositary Receipt (ADR), on the New York Stock Exchange (NYSE) or another US exchange rather than on BMV/MexDer, or have a dual listing, according to Nelson.

“This means that much of the activity in stocks and derivatives will go through the US rather than the Mexican exchange itself,” Nelson says. “So that takes a lot of liquidity away from Mexico.”

Hector Casavantes, director of electronic trading services at Mexican broker-dealer Finamex, has a different take, however. While he agrees that Alegría and MexDer have been aggressive in terms of performance improvements—response time is eight to 12 seconds, according to the exchange—and technological investment and enhancements to bring high-frequency traders into the market, pricing needs to be improved.

From a wholesale business perspective, Mexico needs more “modern” pricing options for the high-frequency trading community—such as, for example, liquidity rebates—as well as better market data costs and simpler and cheaper clearing and settlement models, Casavantes says.

Alegría explains, however, that the exchange’s pricing is “quite competitive” but that with the incorporation of new players with more aggressive trading strategies, there may be an opening to offer better “all-in” execution costs, he says.

Progress Software’s Nelson goes a step further, suggesting that the Mexican market would benefit if there were fragmentation at the exchange level and the BMV and MexDer split. He says this is unlikely to happen in the near-term, but is something that regulators should consider. 

“Some argue that there is a bit of a conflict of interest there, where perhaps the two bodies should be separated,” Nelson says. “Therefore, instead of having a monopoly of the provision of exchange-listed instruments, there would be a little bit of competition. Two bodies competing—even if they have separate listings—may be more successful than just one body, which will move more slowly.”

Alegría disagrees with that idea and says this partnership helps to provide faster and better execution times and new strategies, services and co-location opportunities.

Plenty in the Hopper

With its technology on solid ground, Mexico needs liquidity to truly take off. Aditat’s Koopman says this starts with attracting high-frequency players to the market. There is a lot of hope that the CME deal will do the same for MexDer as it did for BM&FBovespa, which has been a successful partnership. Alegría says the alliance also presents an opportunity for MexDer to market new products.

Alegría adds that MexDer will be pushing hard to attract international players on the options side, as much of the play is coming on the futures end of the spectrum. He says the BMV options index saw a 50 percent volume increase in trades from the fourth quarter of 2009 through the first quarter of 2010. 

Additionally, MexDer will look to tap into what Alegría says is a $100 billion pool of assets in the mutual fund industry. These players are not necessarily high-frequency players, but they are important on the options side—Alegría says they will add depth and create delta and gamma hedging needs in the market. This will create hedging needs on the banks’ side and thus allow for international high-frequency traders to come in looking for arbitrage opportunities.

Also on Alegría’s agenda is preparing to list 30 new names of Mexican stocks, which will take at least the rest of the year. “We want to go step by step depending on demand, but we can go to 30 more names of Mexican stocks that we can list available for trading,” he says. “We are ready to go, but we need to wait for demand. I think we will see a slow start and then suddenly it will explode. We saw this in futures—two or three pension funds will start doing this, then hedge funds and then everyone is going to jump in.”

Finally, there is volatility. Several years ago, the Volatility Index Mexico (Vimex) was launched to track the volatility of options on the Mexican stock market. Alegría says MexDer has been closely studying the index and there are plans to launch a derivative based on the index, although this is unlikely to happen for a while.

“That is high on the priority list for products, but we need to work a little bit more on the underlying options before launching a volatility product,” he says. “We have the index now, so there may be a time, soon, to start thinking about launching a derivative on that index.”