Market Evolution: Predictions for the

Future

ACI DenmarkSeptember 20, 2012

James SinclairCEO, MarketFactory jsinclair@marketfactory.com

Tonight

1. Why is FX different?

2. Where are we now?

3. Where are we going?

WHY IS FX DIFFERENT?

Global, Dispersed, Fungible

Europe$725bnper day

Asia$375bnper day

Americas *

$400bnper day

Chicago$100bnper day

* Excludes Chicago

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)

Resilient

1,039 Banks; 580 Buy-side Banks; 300 Prop Funds; Real Money; Hedge Funds; Corporates

euro, mergers consolidation

euro, mergers, consolidation

Retail

Aite Group

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

Com

ple

xEasi

er

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

Com

ple

xEasie

r

WHERE ARE WE NOW?

CLS FX Spot VolumeFlat recently

CLS data indexed to July 2010

CLS FX Spot vs. US EquitiesBut better than other markets

CLS, US Consolidated A, B, C tape

CLS FX Spot vs. Europe EquitySimilar in Europe

CLS, Thomson Reuters Monthly Market Share – all lit, hidden, auction, dark, off order books

FX, US Bonds, US EquitiesClearly correlated

CLS, US Consolidated A, B, C tape, SIFMA primary dealer treasury, corporate>1 yr, agencies

Greenwich Associates

Playing the Scale GameBut is it the only game to play?

Customer FX Growth

© MarketFactory, Inc. 2011

Interdealer FX Market in 2011Interdealer FX Market in 2003

ReuEBSCMEDB

Structure akin to US treasuries: Interdealer: Brokertec, eSpeed;Customer: Bloomberg, TradewebStill similar + GovEX.

Prop Shop

BoA JPM

UBSDres

-dner

Citi

Prop Shop

Prop Shop

Prop Shop

Prop Shop

HS

Real Money, Corporates

CXFXal

l CX

Integral

Execution through ECNs, banks and some funds

Not shown:Futures brokersRetail

Com-

merz

FXall

Barx

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

Pragma: They may raise costs

June 29, 2012 market. Red dot indicates 10% with longest queue length. HFT and the Hidden Cost of Liquidity, Pragma Securities, July 27 2012

The highest volume US stocks are the most expensive to trade!

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

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

Major ECNs and CMETrends are converging

Major ECNS and CME

CLS vs. Established ECNsEstablished ECNs are losing share

CLS, Major ECNS

Low Volatility, Low Volumes

FX Options

BIS Survey; Aite Group

FX Options

BIS Survey; Aite Group

SO, WHERE ARE WE GOING?

PredictionsThe Easy Ones

• Emerging markets (RUB, CNY)• New platforms, new exchanges

(e.g. CME Europe)• Asset managers seek better FX access• TCA

PredictionsThe Harder Ones

• Volume• Fragmentation / Consolidation• Which products?• How traded?

• Retail• US elections; fiscal cliff; eurozone economy• Basle III, MIFID II, Dodd-Frank, EMIR

Tighter SpreadsEquities Market Turned Agency

Aite Group

Modest Net Consolidation

Customers value relationshipsFINRA

Fragmentation

US cash equities: 13 exchanges; 50 dark pools; plus broker-dealers

European equities: 28 lit books; 2 hidden; 20 auction markets; 13 dark books.

Many Platforms will Succeed

• Bring New Segments

• Enable hedges not economic before

• Grow market

Democratization of Options

BIS Survey; Aite Group

34

Electronic FX OptionsHybrid

Broker-backed Order books RFQ

Major single bank platforms: UBS, Deutsche Autobahn and BARX

CME FX OptionsA model for options?

CME

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

Algorithmic Trading

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

DMAThe Agency Model

• New Participants, More Participants• Next Phase of Market Growth

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

Greenwich ForecastOur best days are ahead

APPENDIXIN CASE OF QUESTIONS ON THESE TOPICS

High-Frequency Trading

Choose your definition:1. Systematic; Quant; <1 day holding

2. High volume; Low inventory

3. CFTC (US govt) defn.

25% of volume, but highly visibleIrene Aldridge – Estimating Proportion of High Frequency Traders, July 10, 2012

Growth by Geography