Financial Services 2015 – Speculation on the Future of the Business

1. Financial Services 2015 – Speculation on the Future of the Business Stanford-Tsukuba/WCQF Workshop March 9, 2007 Howard Bomze, DSc.

2. Disclaimer • The opinions expressed in this presentation are those of Howard Bomze and do not necessarily reflect those of Lehman Brothers or any of its affiliates.

3. Introduction • Who am I? • SVP Global Equities IT, Lehman Brothers • hbomze@lehman.com • background • What is this talk about? • speculation on the future of the Financial Services business landscape • one always takes some risk predicting the future • risk, by the way, plays a prominent role in this future view • some of the predictions are made in logical steps • some are made in big leaps, as you will see

4. The changing landscape • Electronification -> Transparency + Speed • exchanges move to almost total automation • global consolidation such as NYSE-Euronext • ECNs • exchange-ECN combinations • NYSE-ARCA • NASDAQ-INET • exchanges have bought them mainly for their electronic trading systems • other ATSs • Broker/Dealers - proliferation of internal crossing systems • 4 a few years ago, 40 today • Other liquidity seekers – LiquidNet, LAVA, etc. • brokers providing DMA, DTM, DTCap products • sophisticated client-side systems

5. The changing landscape • Regulation • RegNMS • MiFID • Growth in hedge funds • sweeping up inefficiencies • primary source of flow • Unbundling • breaking out charges for execution vs. value-added services • will drive specialization

6. What does it mean? • Transparency + speed = reduced market inefficiencies • Clients controlling more of their flow • sophisticated and affordable OMSs and EMSs • affordable, powerful systems for algorithmic trading • using Direct Market Access (DMA), Direct to Model (DTM), Direct to Capital (DTCap) • Disintermediation of the human trader • some predict a factor of 10 reduction • Increasing number orders and transactions • more stress on the pipes and plumbing • increased requirements for capacity and low latency • number of orders 10x to 20x the number of transactions

7. What else does it mean? • Agency (low risk) commissions going to 0. • particularly DMA • Fractured liquidity • RegNMS and MiFID opening up more pools of liquidity • RegNMS – US • protected markets • affects dark pools and how they operate • trade thru rules (ISO orders) • MiFID – Europe • Systematic Internaliser • pre and post-trade transparency rules

8. How to respond? • Monetize the flow • Value-added services - unbundling • portfolio and trading analytics • research • opening access to algorithmic trading systems • Prime Services • Take on risk for the client • risk free trades • new structured products • Proprietary trading

9. AmazonBay • Dresner Kleinwort video • An alternate universe

10. Monetize the flow • Internal crossing • save on exchange fees • make transactions anonymous • minimize market impact • some market data income potential • Client analytics • deeper client insight • proactive selling to the client based on their trading characteristics • but! clients want anonymity • trust relationship required

11. Value-added Services • Research • unbundling will put a lot of pressure on this area • Portfolio and trading analytics • pre-trade • performance and risk attribution • portfolio construction and rebalancing • trading analytics • impact vs. execution risk analysis • cost and risk vs. horizon • post-trade • execution performance analysis • transaction cost analysis - TCA

12. Value-added Services • Access to algorithmic trading systems • brokers are allowing clients to direct trades to their algorithmic trading systems • an area for differentiation based on the quality of the algorithms • clients can adjust parameters to suit their needs • algorithm type • VWAP, Target Strike, With Volume • start and end time • limit price • participation rate • aggressiveness, etc.

13. Value-added Services • Prime services • Traditional services • Financing, stock loan and back office processing • New services • Hedge fund in a box and now the hedge fund hotel • technical support, administrative support, premises, marketing and incubation.

14. Taking on Risk for the Client • Market making • Guaranteed order types • e.g. guaranteed vwap orders • firm takes the risk • firm makes extra money if it can trade at better than the benchmark • New products • Structured products • limited transparency + limited liquidity = higher profit margin • of course it means you have to price it right • can be tailored to customer’s individual requirements

15. Proprietary Trading • Trading for the firms internal accounts • Firm taking on risk • 2004 profits split 50-50 between agency and principal (proprietary + other risk based trading) • Estimated 2015 profit split 70% principal vs. 30% agency • Advantage with access to internal flows • must not be seen as predatory vs. clients • Entering emerging markets • Eastern Europe, India, China • Higher risk -> higher potential profits

16. References • The changing exchange • http://www-03.ibm.com/industries/financialservices/doc/content/bin/fss_changing_exchange.pdf • The trader is dead, long live the trader! • http://www-935.ibm.com/services/us/imc/pdf/ge510-6270-trader.pdf • AmazonBay • https://online.dresdnerkleinwort.com/2015/

17. References • LSE, NYSE, OMX, Nasdaq, Euronext ... Why Stock Exchanges Are Scrambling to Consolidate • http://knowledge.wharton.upenn.edu/createpdf.cfm?articleid=1428&CFID=3853799&CFTOKEN=13220194