Bloomberg News

Faster Edge Sought for Latin America ADRs in New Venue

December 28, 2011

(Corrects name of company in sixteenth paragraph.)

Dec. 27 (Bloomberg) -- William Karsh, a former executive at Direct Edge Holdings LLC, is raising money for an electronic venue that that would give investors a new place to buy and sell American depositary receipts tied to Latin American stocks.

The platform, based in a yet-to-be-determined Latin America country, would trade securities listed in the U.S. and Canada, said Karsh, the former chief operating officer at the fourth- largest American equities exchange owner. Possible locations include Costa Rica, El Salvador and Panama, he said.

Karsh’s project would cater to traders seeking to incorporate news into prices faster and who may be attracted to a venue where information from New York arrives a split second quicker than it does in Sao Paulo, and vice versa. The system will give market makers trading ADRs of Petroleo Brasileiro SA and Wal-Mart de Mexico SAB the chance to arbitrage prices between cities, Karsh said in a telephone interview. Individual investors may get better prices in the process, he said.

“There’s a need for an electronic trading system to offer an alternative to what’s trading in Latin America but it must be done in a way that doesn’t step on a lot of toes,” Karsh said. “We’re not trying to be a disrupter of other people’s business. We want to bring more business into the region.”

Latin American Venues

Investors would be able to trade ADRs, exchange-traded funds and other products in multiple currencies, he said. Karsh’s initiative follows plans by U.S. exchange operators Bats Global Markets Inc. and Direct Edge to create platforms to buy and sell Brazilian shares. Chi-X Global Holdings LLC, owned by New York-based Instinet Inc. and six brokers, formed a venture with Sao Paulo-based exchange company BM&FBovespa SA to trade Brazilian stocks in different currencies next year.

Instead of seeking a way to trade shares listed in Sao Paulo, Karsh’s project, called the Emerging Markets Virtual Xchange, would be limited to ADRs and other products tied to shares in Brazil, Mexico and other Latin American nations, he said. Trading is planned for the second quarter, he said.

A new venue in Latin America may find it difficult to convince brokers that it will be able to carry out clearing, the process of guaranteeing delivery of shares and funds that happens after a transaction occurs, said Bernardo Mariano, an analyst at Equity Research Desk LLC, in a phone interview.

“If you’re not a well-known exchange with a household name, it will be very hard to compete,” said Mariano, whose Greenwich, Connecticut-based company advises hedge funds and institutions about exchanges and trading platforms. “What’s the advantage?” he said. “If you’re in a tax haven, maybe there’ll be some benefits, but it will still be hard to convince people to be comfortable with your clearing.”

Seeking Buyers

The platform will lower post-trade processing costs for active firms through netting, which offsets buy and sell transactions, and charge lower fees to execute against existing orders, Karsh said. U.S. brokers will also be able to clear trades in the U.S., he said.

The venue, which will use technology to match orders from Fundamental Interactions Inc., a New York-based technology firm that owns part of the company, plans to sell equity stakes to about five U.S. and Latin American banks or brokers, Karsh said.

No firm has committed to investing in the platform or “written a check,” he said. “We’re in the really early stages in terms of getting the paperwork done, ordering the equipment, getting the data center and the ducks all lined up.”

Karsh’s firm is creating a broker to operate the platform and working out clearing and settlement issues for traders from Latin America, Karsh said. Conversions will be done for investors that want to trade the ADRs or products in another currency, he said.

Synthetic Ordinary

Instead of buying and selling shares in Petrobras, a customer in Latin America would be able to trade the ADRs in U.S. dollars, reais or another currency, Karsh said. Buying and selling ADRs in the currency of the underlying company’s domestic shares replicates the stock by creating what he calls a synthetic ordinary.

“You can do it at a price point that’s significantly cheaper than what they could get in that country,” he said.

The goal is to get 1 percent of overall volume in ADRs and Latin American securities, with 0.7 percent from investors trading primarily U.S. products, Karsh said.

Fundamental Interactions will provide its “ATS in a box” that already enables brokers to match buy and sell orders in U.S. equities from customers, Julian Jacobson, president and chief operating officer, said in a phone interview. He said he expects the venue, which can support options and futures trading, to be profitable by the end of its first year.

Trading Hours

The system will be able to trade all U.S. and Canadian securities, not just ADRs or products tied to Brazil, Argentina or other Latin American countries, Karsh said. While equities can trade outside the U.S., such as on Deutsche Boerse Group AG’s Xetra system, little volume occurs there even for active stocks. EMVX will be open during U.S. trading hours.

Brazil’s depositary receipts programs accounted for 18 percent of the value traded in global depositary receipts programs in the first 11 months of this year, JPMorgan Chase & Co. said in a year-end report. NYSE’s two most-active ADRs by value traded are Vale SA and Petrobras, the bank said.

Bats, based in Lenexa, Kansas, said in February it was seeking to introduce an alternative trading platform for Brazilian shares with Sao Paulo-based asset manager Claritas Investments. Direct Edge in Jersey City, New Jersey, said last month it would build an exchange in Rio de Janeiro that would begin trading by the end of 2012. Both companies must find a way to clear and settle the contracts domestically.

Direct Edge faces “difficulties” in its plans to start a trading platform in Brazil because BM&FBovespa is unlikely to allow the company to use its clearing services, Regina Longo Sanchez, an analyst at Itau Unibanco Holding SA in Sao Paulo, wrote in a note to clients on Nov. 21.

Shares in BM&FBovespa have dropped 23 percent this year through Dec. 23, in part because of concerns over competition. That compares with the 19 percent decline in the 26-company Bloomberg World Exchanges Index.

“We’re not trying to trade securities that settle in the country of origin,” Karsh said. “We want to trade securities that look like securities that settle in the country of origin.”

--Editors: Chris Nagi, Stephen Kleege

To contact the reporter on this story: Nina Mehta in New York at nmehta24@bloomberg.net.

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net.


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