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/conte nt/bin/fss_changing_exchange.pdf http://www- 03.ibm.com/industries/financialservices/doc/conte nt/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