Despite Risks, Brazil Courts the Millisecond Investor

SíO PAULO, Brazil - At a time when the mere phrase “high-frequency trading” makes some investors queasy, Brazil's stock exchange is putting out the digital welcome mat.

In recent years, the BM&F Bovespa stock exchange in São Paulo has taken steps to make its market more friendly to high-speed traders, even as many regulators around the world are casting an increasingly skeptical eye on the sector after a series of well-publicized market malfunctions in the United States.

Lawmakers in Canada, Australia and the European Union have been looking at imposing limits on such traders, whose investment time horizons are measured in milliseconds rather than months.

“Given the attention and the political discourse on the perceived dangers of H.F.T., exchanges are very reticent to be aggressive in promoting and attracting high-frequency trading,” said Andy Nybo, an analyst at the Tabb Group.

But in Brazil - as well as in other developing economies like Chile and Mexico - exchanges are actively courting high-speed traders without much resistance from their regulators. The appeal is that the traders can execute thousands of trades a second, resulting in big fees for the exchanges.

The BM&F Bovespa, which closed its open trading pits in 2009 in favor of electronic trading networks, is ramping up efforts to support computerized trading. Last month, the Brazil stock exchange introduced a new lightning-fast computer system, known as Puma, that allows high-speed traders to get in and out of trades more quickly. The exchange has offered these traders discounts since October 2010.

The BM&F Bovespa is “very open about what they are looking to do. They really have been aggressive in welcoming all types of strategies,” Mr. Nybo said.

The stocks on the Brazilian exchange are cumulatively worth $1.2 trillion, but the average daily trading volume on the exchange is only about $3.7 billion. In the United States, a single major stock like Apple can trade more than that each day.

The comparatively low volumes are in part a reflection of the relatively limited involvement of high-speed traders, who still only account for about 10.6 percent of all stock trades in Brazil. Although that is up from 8.5 percent in 2012, it is still a fraction of trading in other large global markets. In the United States, such firms dominate a majority of the trading, and in Europe, they are responsible for about 45 percent of the trading, according to Celent, a research and consulting firm.

The Brazilian exchange's push seems like a risky gambit to many critics of the acceleration of American markets over the last decade. High-frequency traders have been accused of using technology to move share prices for their own advantage and to trick traditional investors. They have also taken some of the blame for market mishaps like the “flash crash” in May 2010, when stock indexes dropped nearly 10 percent in less than half an hour.

Wallace C. Turbeville, a senior fellow at Demos, a research group in New York, said most offers made by high-frequency trading firms were “illusory”: they exist not to be executed, but to measure, distort and exploit market sentiment, increasing volatility and costs for other investors.

Brazilian executives say they believe they have been able to avoid problems through strict regulation. They are also trying to keep at bay many of the other technological developments that have complicated American and European markets. Brazil has, for instance, banned dark pools, private venues where trades can be executed out of the public eye.

And unlike in the United States, which has 13 public stock exchanges, the BM&F Bovespa remains the only place to trade stocks in Brazil.

Cicero Vieira, the BM&F Bovespa's chief operating officer, said a single trading environment meant computerized trading firms had fewer opportunities for arbitrage - simultaneously selling high in one place and buying low in another - which should keep high-frequency trading from growing past 20 percent or so of total volume.

“When it comes to H.F.T.'s, there is no such thing as zero risk,” Mr. Vieira said. “Our philosophy is to contain the impact of errors.”

Danielle Tierney, an analyst with the Aite Group, a financial advisory firm in Boston, said that Brazil's tough regulations, including a prohibition on anonymous trading, and its less complicated market structure had helped prevent the problems that have drawn scrutiny in America.

“Risk controls can always fail, but compared to where we were in the U.S. in 2010, Brazil is much better prepared,” she said. She added that having a single stock exchange with low trading volume makes it easier to spot problems.

Brazil's market regulator, the Comissão de Valores Mobiliários, has so far left regulations governing high-frequency trading to the exchange, but it says it is observing the segment closely.

For the BM&F Bovespa, the push to attract high-speed traders provides a way to keep out competitors. Direct Edge, a United States exchange with close ties to electronic trading desks, has applied to operate in Brazil, but approval is not expected before 2015. In the United States and Europe, upstart exchanges won market share by being more accommodating to speedy traders.

The BM&F Bovespa is also eager to get the benefits that electronic trading has brought to the United States. Several academic studies have suggested that the competition among the firms has led to smaller differences in the spread between the prices at which traders are willing to buy and sell stocks, making trading cheaper for slower investors.

“That will increase liquidity and reduce spreads and distortions,” Mr. Vieira said.

Brazil has been steadily making its systems more hospitable to high-frequency firms. In 2009, the exchange opened the door to more computerized traders by creating a data center that allowed firms to co-locate within a few feet of the exchange's server, cutting down the delays associated with data traveling through fiber optic cables.

Chris Concannon, a partner at the New York-based electronic trading firm Virtu Financial, said that the exchange had worked “very hard at encouraging new participants into the market, both electronic and traditional.”

But the exchange ran into the limits of the speed of their own computer systems. The new Puma system cuts the time for order execution to around a single millisecond from 30 while increasing stability and capacity. The technology was developed together with America's largest futures exchange, the Chicago Mercantile Exchange. The BM&F Bovespa and the CME own 5 percent stakes in each other. Ms. Tierney estimates that Puma cost at least $200 million and perhaps as much as $500 million.

The new technology has been available since 2011 to traders on Brazil's derivatives markets, which BM&F Bovespa also operates, and is scheduled to include the bond market by early next year.

Mr. Concannon said that they had already noticed a “substantial improvement in the exchange performance with these upgrades.”

The eagerness of high-speed firms to enter Brazil points to their search for new markets as they experience difficulties in sustaining their profits in the highly competitive United States. Most of the high-speed trading activity has so far come from non-Brazilian firms like Virtu. Brazilian brokers have been winning some of this business and consequently welcoming the developments.

Yet, there are still those who sound caution on these initiatives. Felipe Santos, responsible for electronic trading at the São Paulo fund manager Equitas Investimentos, said that although high-frequency trading might make it easier for everyone to buy and sell stock in big companies, especially the largest ones, it had its limits.

“You cannot create volume out of thin air,” he said. “You need real investors, too.”

Dan Horch reported from São Paulo, Brazil, and Nathaniel Popper from New York.