Electronic FX in Latin America: Tremendous growth on the horizon

September 2021 in Regional Perspectives

Electronic FX trading is becoming more widespread in Latin America, driven by trading firms’ ambitions to reduce their costs, increase their operational efficiency and generally become more client-focused. This has resulted in the growth of online platforms and electronic FX trading delivery channels across the South American continent.

There has also been increasing use of algorithmic trading in the region’s largest and most sophisticated markets – Brazil and Mexico. But what specific currency and FX trading products and services are in most demand? And can the electronic platforms and local expertise of the leading regional FX providers help international investors gain access to the fast-growing LatAm markets?

Matt Kassel

“The proliferation of technology in the region is connecting the local market participants to the larger FX market in a way that is quickly transforming their abilities to execute quickly and efficiently.”

Improved connectivity

Matt Kassel, chief operating officer at US-based FX trading platform Edgewater Markets, says that the adoption of e-trading for FX throughout Latin America began some years back, primarily through the use of existing legacy systems. But in the past two years, says Kassel, there has been an explosion in the electronification of markets in the Andean region, creating improved connectivity to the world and decreasing the need for previously utilized execution services.

“Technology solutions are being developed and delivered to the region today that offer fully automated streaming non-deliverable forwards (NDF) and spot rates,” says Kassel. “The proliferation of technology in the region is connecting the local market participants to the larger FX market in a way that is quickly transforming their abilities to execute quickly and efficiently.”

Adoption though does vary throughout the region, says Kassel. “Mexico being a deliverable currency is liquid and fully streaming already. The market participants in Mexico are now utilising the various options for distribution and are able to reach clients on all continents without the use of previously expensive legacy central limit order book technology. In the case of Brazil, despite on/offshore restrictions, the market is already electronic and liquid, due to major players having onshore booking capability. The further development of technology is supporting the local participants reach into the larger market and the growth in this space continues to play a larger role amongst the local community.”

When it comes to the services that are most in demand among FX traders in the region, Kassel highlights access to off-shore transactional business, streaming liquidity and execution services. There is also an increasing demand for white label solutions that enable local banks to extend their reach.

“There are also a few sophisticated trading desks that have also adopted algo trading, and this space continues to be a topic in all conversations with the banking community interested in further technological growth,” says Kassel.
There are a number of ways for local traders to get access to some of these tools, says Kassel. “Global participants and local onshore players who have direct access to technologies such as Edgewater Markets LatAm FX product, are finding their abilities to interact with the larger market is easier than they had anticipated. The local players are elated to welcome the FX market into their onshore activity, and the traditional FX market participants are finding enormous value in being included in the local markets.”

According to Kassel, the focus to invest in technology has become the latest trend in the region, starting with the larger local banks. “The resources being deployed to enhance distribution and reach, thus lowering execution costs, is a pervasive theme in LatAm as a whole, with tremendous growth on the horizon.”

Matt O’Hara

“While there are some challenges which limit the scope of access to LatAm markets for international FX traders, with a combination of innovative thinking and local partnerships we don’t believe that any of them are insurmountable.”

Local presence

An important point to make about electronic FX trading in Latin America is that it is a heterogeneous region, says Matt O’Hara, CEO, Americas of multibank trading platform 360T. “Each country is at a different stage of e-trading adoption and there are important differences and nuances within the FX marketplace of each that technology and service providers operating in the region need to be cognisant of.”

That is why it’s crucial to have a local presence to support clients there and to build strong relationships with all of the key market participants in each country, says O’Hara. He cites 360T’s expanded presence in Brazil as an example. “Having the right people who understand the local markets enables us to build up a strong client base within each Latin American country and then once we are able to connect these onshore pools of liquidity with our global FX community it creates better trading outcomes for everyone.”

For 360T, the strategy is regional but the implementation remains localised. “Mexico and Brazil constitute the two largest FX markets in the region and, yes, the adoption of trading technology there is generally more advanced than elsewhere in the region,” says O’Hara. “But importantly, the technology solutions required by each vary significantly based on local market structures and the nature of the MXN and Brazilian real (BRL) currencies.”

According to data from the Bank for International Settlements, the Mexican peso is in the top 15 most frequently traded currencies in world. It is a CLS currency and highly international, especially in the Spot FX market, with 80% of trading activity occurring outside of Mexico.

Credit is a big challenge for firms trying to access the local LatAm FX markets

By contrast, a lot of the local FX trading in Brazil occurs in the Futures market, it is not a CLS currency and as a consequence international trading of BRL is focused heavily in the NDF market, says O’Hara. “So while the adoption of e-FX trading is accelerating in both of these markets, the actual technology solutions required in each aren’t identical, and therefore it’s important as a technology provider that you have an offering which is broad enough to meet the differing requirements of each.”

But while firms in Mexico and Brazil might, generally speaking, have travelled further down the road in terms of FX technology adoption, those in the rest of the region are still facing the same pressures to reduce costs, minimise risk, enhance transparency and improve returns, says O’Hara. “Partnering with technology providers is a proven way of achieving all these goals and this is why we’re seeing growing demand for e-trading solutions throughout the region, with Chile, Peru and Colombia being particular hotspots on this front right now.”

The types of services that are most in demand can vary significantly, but in this instance the differentiation is more between different customer segments rather than geographies, says O’Hara. “Amongst the real money community we see growing demand for technology tools which can drive workflow efficiencies, reduce operational risks and deliver improved FX pricing. In addition, these firms have a responsibility to their investors and stakeholders to achieve the best returns possible, as well as a competitive incentive to do so, and therefore there is a lot of interest from them around accessing and consuming high-quality data feeds that can both improve their execution outcomes and help them to benchmark their FX trading activity.”

Meanwhile, the regional banks are looking for the transparency, efficiencies and price improvements that can be gained by putting multiple liquidity providers into competition, which pushes them towards multibank platforms, says O’Hara. “Corporate clients in Latin America are also very focused on transparency, but less for reasons of ensuring that they can prove best execution and more because it can significantly help them from an audit and compliance perspective.

Clearly, executing FX transactions via an electronic system which records everything and is then able to produce a complete and comprehensive audit trail of all trading activity helps in this regard. Streamlining workflows is also important for these firms, because FX trading is simply one amongst many of their daily tasks and therefore they are looking for technology which can make this process quicker and easier, enabling them to focus on other more mission-critical elements of their jobs and thus increase productivity.”

The challenge of credit

The biggest challenge for firms trying to access the local LatAm FX markets is credit, says O’Hara. “So, for example, while a trader sitting in New York could access a multibank platform to try and interact with local FX market participants in Mexico, they will probably only be able to face a small number of firms on the platform as a counterparty because of credit limitations.”

360T is currently developing a new product to try and address this challenge, says O’Hara. “We have partnered with a domestic Mexican bank, Banco Monex, to create a credit hub that allows local firms in Mexico to interact with the full range of global liquidity on our platform on an anonymous basis. How this works is that Monex has an excellent credit rating and is therefore able to face off against a wide ranging spectrum of international liquidity providers and in addition is a member of CLS and therefore is able to act as a credit hub.”

This is also broadly representative of 360T’s NDF strategy in LatAm, says O’Hara, which involves connecting the local onshore currency specialists with a global community of active NDF traders. “So while there are some challenges which limit the scope of access to LatAm markets for international FX traders, with a combination of innovative thinking and local partnerships we don’t believe that any of them are insurmountable,” he says.

There’s a broad confluence of factors driving the adoption of e-trading in LatAm, says O’Hara. “The availability of high-quality FX trading technology at an economically feasible cost continues to increase and the value proposition of this technology continues to be demonstrated in other marketplaces. The entire FX market globally, including LatAm, is drifting towards a more transparent and regulated environment, which naturally leads to more electronic trading. On top of this we see firms throughout the region – including central banks – committing to the FX Global Code of Conduct, which helps promote best practices around FX trading. By executing across platforms which have publicly announced their adherence to the Code, firms in LatAm can be certain that they are operating in an environment which meets all of these industry best practices.”

But perhaps the most significant factor influencing e-trading in the region is the nature of capital markets, says O’Hara. “An asset manager that is able to eliminate operational inefficiencies and access better FX pricing will produce better returns to its investors, and this becomes a point of differentiation. A bank that can deploy a world class pricing engine using SaaS technology will be in a better position to compete against large international banks for local FX business and can improve their P&L as a consequence of this. A corporate treasurer with a streamlined FX workflow solution in place can enhance their productivity across the treasury desk, which can significantly enhance their productivity.”

So ultimately, the competitive advantage that comes from e-trading is its biggest driver of adoption, says O’Hara. “And on the flipside, the firms who resist this trend towards greater technological innovation and adoption, risk falling behind their peers.”

Eric Donovan

“Regulation and credit are two factors driving adoption of e-trading in the region. Many of the policies across LatAm restrict liquidity and make electronic trading much more difficult.”

Deliverable vs non-deliverable

When it comes to describing the rate of adoption of e-trading in Latin America, it is better to look at deliverable vs non-deliverable currencies rather than the region as a whole because it is very different, says Eric Donovan, global head of institutional FX at StoneX, the US-based financial services network. “Mexico for example, is fully deliverable and has excellent electronic liquidity anywhere in the world. Spot FX is a welcome product in most regulatory jurisdiction and the Mexican peso (MXN) has very robust liquidity as a result,” says Donovan.

“MXN trading looks a lot more like most G7 currencies in terms of how it trades throughout the world because you can freely deliver MXN outside of Mexico. Brazil, Chile, Argentina and Columbia on the other hand, are non-deliverable and have a variety of capital controls in place. This means that in many jurisdictions, trading those currencies falls under swaps regulation which vastly limits market participation. To be clear there is still an electronic market, but it is considerably less reliable, more fragmented, and more difficult to access than MXN.”

Consequently, while Mexico and Brazil are the two most important currencies in the region, Brazil is non-deliverable and therefore falls far behind Mexico in terms of electronic FX and overall liquidity and trading, says Donovan. Regulation and credit are two factors driving adoption of e-trading in the region, says Donovan. One of the biggest hurdles LatAm banks and trading firms face in accessing FX markets is the ability to access quality credit intermediation through a tier 1 prime broker. “Electronic tools that help solve credit intermediation are as important, if not more important than liquidity aggregation,” he says.

In addition, many of the policies across LatAm restrict liquidity and make electronic trading much more difficult, says Donovan. “All of the tools to have a fully electronic, open trading environment already exist as we can see in Europe and the across most major deliverable currencies. Regulations greatly restrict who can even trade these NDFs, and because of the lack of liquidity and low trading volumes, large scale credit intermediation is also remains much more cumbersome.”

Bart Joris

“It is a two-speed region with the more developed countries such as Mexico and Brazil, taking advantage of their open economies with established e-trading while other emerging nations are in the early days of electronificaiton.”

Transparency and sophistication

The adoption of electronic trading is generally driven by the level of sophistication and transparency of the FX market and the evolution of the adoption rate is no different in Latin America, says Bart Joris, head of FX sell-side trading, customer proposition date & analytics, for Refinitiv.

“Transparency and sophistication create a virtuous cycle which will push e-trading uptake at an accelerating pace,” says Joris. “Sophistication refers to infrastructure, technology and market conditions while transparency is more focused on how open and visible the market is trading such as price discovery, credit and participants. As markets become more mature and countries develop, this will be a natural process that drives the adoption.”

In Latin America, Mexico and Brazil aside, this was slower in the last decades than other emerging regions, for multiple reasons such as political unrest, credit, and infrastructure though recently this was accelerating, says Joris. “With events as Covid, the trend accelerated even further as the electronic market provided quicker access compared to traditional trading. It is a two-speed region with the more developed countries such as Mexico and Brazil, taking advantage of their open economies with established e-trading while other emerging nations focus on developing their economy and are in the early days of electronificaiton.”

Joris agrees with others’ view that adoption varies across the region. “Mexico has clearly a head start followed by Brazil, though we see accelerated activity all over Latin America in places such as Chile, Argentina, and Colombia. Mexico has led since the MXN is the only full convertible currency in Latin America so its internationalization happened much quicker. It was therefore logical that the local market would follow international trends more easily than other countries,” he says.

“Most countries are looking for foreign investment to develop their economy, creating an environment where transparency and sophistication is increased. This triggers the need for more e-trading to provide better access to the market for foreign participants. For an efficient electronic market, price discovery is a key component,” says Joris. “Without knowledge of where the FX market is traded, it is impossible to create a valid electronic price. Manually you can call around to find the correct market levels, though electronically you need to find the data points and afterwards construct your market price for distribution. We see overall progress, as data becomes more widely available, and electronic trading provides more electronic data.”

When it comes to the type of electronic services most in demand, aggregation is critical to supporting price discovery, says Joris. “Further components such as price creation and distribution with or without smart order routers comes second. For algo execution, a well-established electronic market is needed with sufficient electronic data and history available to ensure the models incorporate the correct behaviours.”

This would also help develop effective transaction cost analysis (TCA) tools. “One unforeseen moment can lead to very impactful algo results, which is in general the opposite of what an algo wants to achieve. Simplified TCA on best execution and post-trade market behaviour is important in ensuring correct practices. Electronic markets help to enhance TCA value and increases comfort levels which drives further adoption. For in depth TCA, it is still early days, as reference data is needed and even open visible market information to benchmark correctly.”

For the major countries such as Mexico, Brazil and some smaller countries, there is already either direct access or availability through the assistance of local brokers or banks, says Joris. “Naturally offshore markets offer NDF and Options capabilities if you do not want to trade directly. Foreign traders are looking how to apply their expertise edge in trading models and algos, though do need the necessary technology and transparency. Major market players such as LSEG offer ability to trade locally, aggregation and services to increase visibility via data or provide end-to-end electronic white label systems. They also tend to offer the ability to trade on the off-shore market instruments. Other countries are still in early days and need to progress on infrastructure and transparency.”

There are several drivers for adoption though they are no more different than elsewhere, says Joris. “These are increased efficiency, both operational and intellectually based on analytics, as well as execution speed, distribution and even straight-through-processing (STP) through reduced human errors. The demand for best execution from the buy side and more transparency via STP to regulators are factors that have also helped encourage FX trading firms to adopt e-trading platforms.”