Financial Services 2015 – Speculation on the Future of the Business

Stanford-Tsukuba/WCQF Workshop

March 9, 2007

Howard Bomze, DSc.

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.

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

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

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

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

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

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

AmazonBay

Dresner Kleinwort video An alternate universe

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

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

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.

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.

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

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

References

The changing exchange– http://www-03.ibm.com/industries/financialservice

s/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/

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