Emerging market trading: easier than before?

• Emerging markets are an attractive destination for trading firms seeking new sources of alpha.
• Trading in emerging markets requires mission-critical infrastructure.
• Low latency is critical to arbitrage or market-making strategies.
• Mexico is a key emerging for arbitrage traders.
• The Mexican Stock Exchange is the second largest stock exchange in Latin America.
• Source flexible partners that will allow trading firms to test out their trading strategies in new markets.

Emerging markets have long presented an attractive proposition for trading and investment firms seeking new sources of alpha. With spreads becoming ever narrower on established US and European exchanges, and margins ever thinner, forward-looking trading firms – particularly those specialising in arbitrage or market-making strategies – are clearly aware of the potential of capturing the wider spreads that exist on other exchanges around the world, especially in those markets those where volatility is high.

Challenges vs reality

The reality however, is that setting up a trading operation able to take advantage of such markets is often a tricky - and costly - undertaking, with no guaranteed return on investment. Which is why firms are often reluctant to take the plunge.

The challenges are many and varied. Language barriers, regulatory hurdles, and lack of local knowledge and expertise are all obstacles to overcome, before firms even start navigating the infrastructure and communications complexities associated with trading. This is why even the larger proprietary trading and market-making firms, who generally have the resources to build and run infrastructure to trade on exchanges in US and Europe, often struggle to establish a presence on less familiar venues overseas.

However, those firms that are able to overcome the challenges, can reap significant rewards and gain an early led on their competitors.

Everyone is talking about Mexico

One market that is generating a strong level of interest currently is Mexico. The country operates two of the largest stock exchanges in Latin America - the Mexican Stock Exchange (BMV or Bolsa) and the newer Institutional Stock Exchange (BIVA) – as well as MexDer (the Mexican OTC derivatives exchange), all based in Mexico City. Bolsa also operates the international quotation system (SIC) for trading foreign stocks, which has seen a threefold increase in volume in the last five years, driven mainly by ETFs.

So how can US-based firms take advantage of the opportunities that Mexico - or any other emerging market – offers, with minimal risk and minimal investment?

The key is technology. Trading firms need to test markets to see if its worth a long-term investment not just in terms of investment capital but things such as staff and office space. Many trading firms are simply interested in accessing and hedging certain markets without short term or long-term structural investments. Technology and in particular specialised network connectivity can provide access to markets for traders without needing to incur additional costs.

In Mexico for example, which is fast becoming a regional hub for high-frequency and systematic traders, firms are accessing that market from all corners of the US region without a local footprint utilising the increased low latency connectivity and infrastructure availability to Mexico.

Mexico’s BMV and BIVA have made it easier for technology and connectivity providers to access their exchange for international trading participants.

From my vantage point the increasing accessibility to Mexico City and in particular BMV and BIVA is part of the opening up of Latin America’s capital markets industry. Brazil is another example with the B3 exchange making it easier for North American and European traders to trade on their exchange. Once again working with technology and infrastructure providers to make it simple and easy.

Entering emerging markets

Technology is the core of high frequency and quant trading and its key that trading firms find infrastructure partners that understand the market and the nuances of emerging markets. Trading firms need to work with technology providers that understands their need to test new markets and work with them to avoid known pitfalls and also support them to reduce costs.

The key things to consider in working with technology providers if you are a trading firm seeking to dip into emerging markets, rather than signing long-term contracts, sourcing racks, power, cross-connects, shipping equipment, and so on, find a partner than can do that heavy lifting for your team. Hosting equipment, connecting equipment to exchanges, enabling them to source historical data, test the latency back to their own PoP, and running non-production simulations take time and effort. It's key to work with technology providers that can make this process more onerous so you can work on research and developing your trading strategy.

In conclusion, there is a myriad of opportunities in emerging markets and it’s becoming much easier now with upgrades in technology and infrastructure. Don’t miss out on the potential of emerging markets.