A Chilean court will soon decide whether to weaken the Santiago stock exchange’s near-monopoly on trading.
The way it works now, brokers at Bolsa de Comercio de Santiago -- which controls 98 percent of stock trading in the $203 billion market -- are compelled to keep their orders exclusive to that exchange for three minutes. Only then can they shop them at rival markets like Bolsa Electronica de Chile and Bolsa de Valparaiso -- and they still usually don’t.
The government is seeking to inject competition. The office of Chile’s economic prosecutor, which is overseen by the Economy Ministry, wants all bids and offers to be available immediately on any exchange. Traders at different markets could then compete on price, potentially allowing investors to get better deals. A further benefit: incidents like the recent Cascades scandal, in which shares of the holding companies that control fertilizer company Soc. Quimica & Minera de Chile SA were manipulated, could be harder to pull off.
“If the smaller players are able to provide better prices, we will see them gradually taking market share,” said Pedro Pablo Larrain, a money manager who helps oversee $160 million in assets at multi-family office Sartor Investments. “A market with more competition could also have avoided scandals that have affected investor confidence.”
Chile finds itself behind other nations in modernizing how its exchanges work. In most major markets, exchanges are “demutualized,” meaning they’re publicly traded corporations, not private clubs that only let their members in.
Before it demutualized, the formerly insular culture at the New York Stock Exchange fueled a scandal more than a decade ago where traders enriched themselves by giving clients worse prices. The U.S. Securities and Exchange Commission fined five market-making firms in 2004 for their actions. In the aftermath, the regulator spurred competition between U.S. markets, forcing brokers to route orders to whatever exchange or alternative venue has the best prices at any given time.
In Santiago, the brokers who control the exchange have a reason to keep trades there: as owners, they’ll make more money. The rule requiring orders to remain on one Chilean market for three minutes resulted from a 2005 agreement among the exchanges.
Bolsa de Comercio de Santiago says the government’s proposal would actually harm competition by reducing incentives for the exchanges to invest in better technology.
“The prosecutor’s request is illogical, as it seeks to increase competition in the market by killing competition between the exchanges,” Cristobal Eyzaguirre, a lawyer for the Santiago exchange, said at a hearing in Santiago on July 21.
Bolsa de Comercio’s argument is that exchanges compete by offering brokers and their clients a pool of liquidity. By being forced to share that liquidity -- their main asset -- it kills any motivation to invest in better and faster trading platforms or improve risk control to distinguish the product from competitors, executives from Bolsa de Comercio say.
According to a study sponsored by the exchange, less than 0.2 percent of trades between 2010 and April 2015 on that exchange were done by brokers that deliberately ignored or had access to better prices in other bourses.
Because the country’s dominant exchange gets to hog orders for three minutes, liquidity naturally pools there, depriving investors of the opportunity to get better prices on other markets, the economic prosecutor said at the July 21 hearing.
Business at Bolsa Electronica, Chile’s second-biggest exchange, has dwindled in recent years. Its share of stock trading fell to 1.2 percent in 2013 from 7.2 percent in 2004.
“Interbourse operations are the natural way to operate for most countries, and the same should happen in Chile,” Juan Carlos Spencer, the chief executive officer of the electronic exchange, said at the July 21 hearing.
Then there’s the Soc. Quimica & Minera de Chile scandal.
In 2014, Chile’s securities regulator imposed record fines totaling about $164 million on Julio Ponce Lerou, the former chairman and controlling shareholder of SQM, as well as brokerage Larrain Vial SA and other people.
They were accused of a scheme through which they would sell shares of the holding companies through which Ponce controls SQM at artificially low prices with an agreement to immediately repurchase them at a higher price, artificially booking profits. The transactions were placed on the Bolsa Electronica and the Santiago exchange.
“If markets had been interconnected, other traders could have stepped in and grabbed those shares at a lower price,” said Sartor’s Larrain, who isn’t closely related to the founders of the Larrain Vial brokerage.
The Valparaiso exchange, Chile’s oldest bourse and also it’s smallest, is opposed to the prosecutor’s request, surprisingly. With just 0.02 percent of all trades in 2013, exchange officials are concerned that a victory for the prosecutor in a ruling that would come down in the next few months would result in years of re-writing the rules and extended legal battles, delaying a resolution to the point that the bourse may not be able to hang on that long.
Instead, Chairman Carlos Marin Orrego says that courts should better enforce existing rules that require interconnection with only limited restrictions, eliminating fees and other requirements that discourage trading between exchanges.
“We don’t need any new laws,” Marin Orrego said. “We need Santiago to obey the law.”