Capital Market Infrastructures: reshaping relations

For decades, Brazilian capital markets infrastructures did not allow any competition. However, this has changed since new players have been admitted. Thus, relations between participants and authorities must be reshaped, and a new regulation is expected to enter into force soon. Such regulation is likely to introduce innovative provisions to address cases of non-compliance with legal and regulatory provisions that prohibit certain conducts. Participants must be aware of these adjustments, so that they avoid administrative proceedings or being prevented from developing new business models.

So far, regulation has focused on entities directly operating in regulated markets, such as financial institutions and brokers/dealers, and on transactions carried out through their platforms. In the capital markets, the scope of regulation is wider, given that the Brazilian Securities and Exchange Commission (CVM) also oversees publicly-held companies and investors. Though, regulation and oversight of infrastructure services providers has never been in the spotlight.

Among other reasons, this was because a relevant portion of the entities operating as infrastructure services providers did so on a monopoly or oligopoly basis, i.e. without competition. Due to this market structure, formal and informal communication channels between the infrastructure entities and the regulators were established, consequently the actions of the latter were generally concatenated.

On the other hand, the Brazilian finance and capital markets have been undergoing profound changes, following a trend that is felt in more mature markets towards allowing the admission of new market participants, thus increasing the number of competitors. Barriers to entry have been reduced due to, among other factors, the appearance of Fintechs. These entities combine technology and innovation in the provision of payment and other financial services, so that consumers benefit from lower prices and facilitated access to services. In the once extremely restricted financial and payments market, some payment institutions (which later engaged in financial services) started to operate with great success. The same applies to new participants in the securities market, which brought about a radical change in the distribution of securities.

An inexorable trend therefore exists towards also opening the market infrastructure to incumbents. Accordingly, the long existing monopolist or oligopolist structure is bound to disappear in the short or medium term.

As a result, the relations between authorities and entities engaging in market infrastructure activities are expected to change, and to change significantly. Therefore, in order to achieve competition at its fullest, the bases for regulation should be adapted.

The legal framework in place is not suitable for a more open market, in which various entities may perform tasks that are currently carried out as monopolies or oligopolies. Regulation should be modified to include new compliance rules specifically addressed to infrastructure services providers and new remedies in case of non-compliance with applicable rules.

For instance, CVM is expected to allow market participants, such as securities brokers, to internalize order flows, so that the brokers execute customers’ orders against their own accounts. This process replaces the stock exchange entity (B3) and is expected to increase the market efficiency due to increased competition. More on this in another text in this issue.

However, CVM must ensure that rules regarding price formation are properly observed, because there will be several entities which execute orders. In order to stimulate adherence to the price formation provisions, CVM could create a specific channel through which investors would be able to complain against the broker that unlawfully impaired their orders and require compensation. In addition to the compensation, the authority should initiate an administrative proceeding against the participant, whose penalty could be prohibiting it from internalizing order flows for a certain term or for retail or wholesale customers.

For participants to avoid these proceedings or any penalties, they could, for instance, ask CVM to clarify any doubts regarding the order flow internalization. In spite of that, need, tone and timing are important aspects to be taken into account before submitting an inquiry, especially in a competitive market. And this is due to the fact that the actions of the regulator will not be concatenated with the participant’s as they were before