Citi Securities Services facilitated a discussion with senior executives from the stock exchanges of Brazil, Colombia and Mexico to talk about how these industry changes are transforming LATAM’s capital markets.
Aligning with the US’s T+1 transition
The US transition to T+1 is expected to have major repercussions for financial institutions across LATAM mainly because the region’s equity markets are heavily intertwined with those in the US — and none more so than Mexico’s. “T+1 is very relevant for us in Mexico as approximately 50% of what is traded on the exchange in Mexico is related to foreign securities. As for domestic Mexican stocks, it is estimated that foreign investors generate approximately 70% of the trading volume. We are aligning ourselves with the US just as we did when T+2 went live in 2017 and will be adopting T+1 simultaneously with the US,” shared Roberto Gonzalez Barrera, CEO, Post-Trade Division at Grupo Bolsa Mexicana de Valores (BMV Group).
Other LATAM markets appear to be taking a more cautious approach towards T+1. Although there are working groups in Brazil exploring the merits of T+1, Daniel Demattio, Managing Director, Clearing and Settlement, B3 doubted there would be any substantive changes within the next two years. Meanwhile, Colombia is in the process of understanding the impact a shift to T+1 would have on participants and especially on foreign investors, to assess the right timing for the shift.
Although the case for T+1 is compelling (i.e. less counterparty and settlement duration risk, capital optimisation, better liquidity, etc.), its implementation is expected to be quite challenging. Settlement mismatches between securities trading in T+1 and T+2 markets could potentially create problems for LATAM providers.
“Securities settling in Mexico, the US and Canada will do so on T+1. Of the 50% of foreign securities settling in Mexico, around 70% relate to US ETFs [exchange traded funds] and securities, and the rest are in Europe, which will continue to settle on T+2. Settling in different cycles will be a challenge for local broker dealers,” said Gonzalez. “On the other hand, when executing local stock for foreign investors, local brokers will need to send confirmations — once trades are completed — to either the US broker dealer or the foreign investor, and this then needs to be disseminated onwards to the global and local sub-custodians, so that the trade can settle on the next day. This could be quite complicated. Similarly, we expect there will be FX issues too,” said Gonzalez.
T+1 is also likely to impact other activities, including allocations and affirmations, corporate actions and securities lending. With less time to settle, there are fears T+1 may even result in an increase in the number of trade fails, leading to firms facing more frequent cash penalties or even higher Basel III risk weighted capital requirements.
Beneficial owner markets — including Brazil, Colombia and Peru — could also encounter difficulties should they decide to implement T+1. “In Colombia and Peru — which are final beneficiary markets — we need to know who the final investor is before we can settle a trade. Losing an entire day from the settlement process will inevitably make an existing difficult situation even more challenging,” explained Juan Pablo Cordoba, CEO at Colombia Stock Exchange.
In order to handle the shift towards T+1 successfully, financial market infrastructures (FMIs) and other intermediary providers in LATAM will need to invest into new technologies and automation. Already, there is talk about compressing the settlement cycle even further — either to T+0, or even atomic settlement, which is when there is an instantaneous exchange of assets by two trading counterparties. If used alongside distributed ledgers, Central Bank Digital Currencies (CBDCs)- or digital fiat money backed by Central Banks — could help markets achieve atomic settlement.
A handful of LATAM markets — most notably Brazil — are already conducting proofs of concepts (POCs) into the viability of CBDCs. “The Central Bank has been very focused on digital currencies, having established a working group in 2020, and is also exploring whether permissioned networks could be used to issue tokenised securities, starting with government bonds. The idea is they will be able to facilitate DVP [delivery versus payment] on the network between CBDCs and tokenised securities,” said Demattio.
Evolving with the times
As markets continue to undergo rapid transformation, FMIs in LATAM are quickly adapting in various ways — by giving investors easier access to a wider range of asset classes, and by improving their own operational processes. For example, in order to attract more trading volumes, Gonzalez shared that Mexico’s Central Bank is looking to permit electronic trading of government bonds, an asset class where transactions have historically been carried out on an over-the-counter (OTC) basis. “We are building a Central Counterparty Clearing House [CCP] for bonds, and this should be ready later this year, with electronic trading due to begin in the first quarter of 2024,” said Gonzalez.
As FMIs look to enhance their operational capabilities, many are starting to leverage cloud-based technologies, noted Demattio. Not only does cloud technology enable financial institutions to obtain scalability, but it can also help them net cost synergies, improve their operational resilience and enhance their data management capabilities. “The movement to cloud-based systems is comparable to when many downsized from mainframes to smaller platforms. We are already seeing more market infrastructures such as CSDs [Central Securities Depositories] moving towards cloud architecture,” said Demattio.
FMIs in LATAM also acknowledge the role that fin-tech providers could play in the innovation process. “We recognise we need to be swift and agile when innovating and this is where fin-techs come into play. On some of our more peripheral services, we are partnering with fin-techs as they end up being more cost efficient and offer a quicker time to market,” said Cordoba.
Exchange consolidation gathers momentum
Efforts to facilitate easier cross-border investment, trading, listing, clearing and settlement across LATAM are ongoing. Although previous attempts to integrate the local markets have not succeeded, experts believe the latest initiative — which would see the stock exchanges of Colombia, Chile and Peru consolidate into a single regional holding company — could just work. Under this scheme, Colombia Stock Exchange and Santiago Stock Exchange will each control 40% of the holding company, with Lima Stock Exchange owning the remaining 20%.
Local FMIs believe this scheme — assuming it goes to plan — could help draw in more foreign capital and encourage greater investment by domestic institutions, thereby providing a useful boost to market liquidity across the three countries. “The main objective is to make the market as attractive as possible — not just to participants inside the region, but globally. If you are an issuer, you can list in one country but your shares can be traded in all three markets. With trading, there will be a single rule book and single matching engine for investors across the three markets. We also hope that one day there will be a single CCP covering all three markets. CSDs will remain local, but there will be interconnectedness between them. And finally, there will be a single market data feed for investors too,” commented Cordoba.
While this integration is likely to initially benefit equities, it could be extended to other asset classes as well, including listed derivatives. Nonetheless, Cordoba cautioned that fixed income may take time as it continues to be traded mostly on an OTC basis and trading practices differ between countries.
This is not the first time, however, that LATAM economies have attempted to integrate their capital markets. In 2011, Colombia, Chile, Mexico and Peru announced they would harmonise their respective markets under the Latin American Integrated Market (MILA) scheme. Although MILA had plenty of buy in from the local exchanges, arbitraging regulations and tax requirements together with the absence of a shared currency in the participatory markets ultimately resulted in limited trading volumes.
The most recent initiative attempts to learn from some of the mistakes that plagued MILA. “MILA enabled trading across different markets, but it did not take into account the importance of post-trade,” said Cordoba. By this, FMIs– including CSDs and CCPs — in the participatory markets operated very much independently of each other. “Now we have a single holding company which will own all of the exchanges, CSDs and CCPs which means that the strategy and decision-making is all taking place in a single location,” Cordoba added. This new structure will help ensure there is full interconnectedness between each of the different FMIs, which should make it easier for regional market integration to succeed.
Gearing up for the future
Across LATAM, FMIs are gearing up for the future in a variety of ways — from introducing T+1 and adopting new asset classes to harmonising regional capital markets. There is also a willingness to embrace innovative technologies, aimed at improving investment and operational processes which will all contribute towards the future success of the region.