Market Evolution: Predictions for the Future

1. James Sinclair CEO, MarketFactory jsinclair@marketfactory.com Market Evolution: Predictions for the Future ACI Denmark September 20, 2012

2. Tonight • Why is FX different? • Where are we now? • Where are we going?

3. Why is FX Different?

4. Global, Dispersed, Fungible Asia $375bn per day Chicago $100bn per day Americas * $400bn per day Europe $725bn per day * Excludes Chicago

5. Also…. • Natural interest: real needs • Cross-border capital markets, FDI, trade • Lightly regulated: can differentiate • Strong credit model (CLS, Prime Broker) • Well established (Biblical references)

6. Resilient euro, mergers consolidation euro, mergers, consolidation 1,039 Banks; 580 Buy-side Banks; 300 Prop Funds; Real Money; Hedge Funds; Corporates

7. Retail Aite Group

8. Equities and FX Market Structures are Inverted Equities • Millions msgs per second • Thousands • Real-time broadcast Tick by tick – every tick! • Thousands / second • Centralized markets • Heavy – e.g. Reg NMS • Standardized • NBBO • Established; low difficulty • Full depth of book • None b/c of CCP • Order routing from point of order submission Attribute • Throughput • Symbols • MD Frequency • Order Submission • Fragmentation • Regulation • Market Structure • Price Discovery • TCA • Transparency • Price Filtering • Order Routing OTC FX • Millions msgs per day • 20 pairs; 66% of FX in 6 pairs • Real-time custom snapshots • Max 100 orders per second • Globally fragmented venues • Light – isolated venues • All non-standard; all bespoke • Venue specific • Difficult – lack volume info • 1-3 levels of depth common • Heavy b/c of bilateral credit • Complex decision process Complex Easier Easier Complex

9. Where are we now?

10. CLS FX Spot VolumeFlat recently CLS data indexed to July 2010

11. CLS FX Spot vs. US EquitiesBut better than other markets CLS, US Consolidated A, B, C tape

12. CLS FX Spot vs. Europe EquitySimilar in Europe CLS, Thomson Reuters Monthly Market Share – all lit, hidden, auction, dark, off order books

13. FX, US Bonds, US EquitiesClearly correlated CLS, US Consolidated A, B, C tape, SIFMA primary dealer treasury, corporate>1 yr, agencies

14. Playing the Scale GameBut is it the only game to play? Greenwich Associates

15. Customer FX Growth

16. Interdealer FX Market in 2011 Interdealer FX Market in 2003 CME EBS Reu Not shown: Futures brokers Retail DB Citi Prop Shop Prop Shop Barx Prop Shop Prop Shop BoA JPM Prop Shop HS UBS Dres-dner Integral FXall CX Com-merz FXall CX Execution through ECNs, banks and some funds Real Money, Corporates Structure akin to US treasuries: Interdealer: Brokertec, eSpeed; Customer: Bloomberg, Tradeweb Still similar + GovEX.

17. The HFT Riddle • Their liquidity “lowers costs for users” • They make millions of dollars How do they do both at once? Some hold for μsecs; have no customers

18. Pragma: They may raise costs The highest volume US stocks are the most expensive to trade! June 29, 2012 market. Red dot indicates 10% with longest queue length. HFT and the Hidden Cost of Liquidity, Pragma Securities, July 27 2012

19. Pipping: Repeat of Sub-Pennies in Equities Source: Tick Size Regulation, Intermarket Competition and Sub-Penny Trading Fig 1. Sabrina Buti, University of Toronto, et. al. June 1, 2011

20. An Opinion HFT additive if: • Always there in many pairs; • Use info from other asset classes; or • Hold positions for material time But can we choose? A slippery slope

21. Major ECNs and CMETrends are converging Major ECNS and CME

22. CLS vs. Established ECNsEstablished ECNs are losing share CLS, Major ECNS

23. Low Volatility, Low Volumes

24. FX Options BIS Survey; Aite Group

25. FX Options BIS Survey; Aite Group

26. So, where are we going?

27. PredictionsThe Easy Ones • Emerging markets (RUB, CNY) • New platforms, new exchanges (e.g. CME Europe) • Asset managers seek better FX access • TCA

28. PredictionsThe Harder Ones • Volume • Fragmentation / Consolidation • Which products? • How traded? • Retail • US elections; fiscal cliff; eurozone economy • Basle III, MIFID II, Dodd-Frank, EMIR

29. Tighter SpreadsEquitiesMarket Turned Agency Aite Group

30. Modest Net Consolidation FINRA Customers value relationships

31. Fragmentation US cash equities: 13 exchanges; 50 dark pools; plus broker-dealers European equities: 28lit books; 2 hidden; 20 auction markets; 13 dark books.

32. Many Platforms will Succeed • Bring New Segments • Enable hedges not economic before • Grow market

33. Democratization of Options BIS Survey; Aite Group

34. Electronic FX Options Hybrid Broker-backed RFQ Order books Major single bank platforms: UBS, Deutsche Autobahn and BARX 34

35. CME FX OptionsA model for options? CME

36. How Will Traders Execute? • Revival of direct market? • Fragmented platform market • Block trading – four ways to trade: • Transfer risk to a Bank • Algorithmic Trading (chop it up) • Dark Pools/Order Types (akin ITG Posit, Liquidnet) • Shop through a Voice Broker

37. Algorithmic Trading Trader gets an ‘assist’ from the computer. Can give it to customer

38. DMAThe Agency Model • New Participants, More Participants • Next Phase of Market Growth

39. In Summary • FX is special: real need; global; dispersed • Increasing fragmentation. Modest net consolidation • Emerging markets, options. Regulation helps • Banks have customer relationships. Scale is a strategy, but not the only one • Banks increasingly empower their customers: algorithmic trading, DMA

40. Greenwich ForecastOur best days are ahead

41. AppendixIn case of questions on these topics

42. High-Frequency Trading Choose your definition: • Systematic; Quant; <1 day holding • High volume; Low inventory • CFTC (US govt) defn. 25% of volume, but highly visible Irene Aldridge – Estimating Proportion of High Frequency Traders, July 10, 2012

43. Growth by Geography