Financial Innovation- Drivers and Outcomes,

Need a Balance

Dr. Samer HajYehia, Adv., CFA

Catalyst for Financial Innovation

Resilience

Transparency

Fairness (level the field)

Integrity

Competition

Accountability

Protection

Drivers of Financial Innovation:

International regulation initiatives

Availability of big data

Advancement of technology

Globalization

Shifting competitive landscape

Social networking: more sensitivity to consumers, fast dissemination of info, targeted

products and marketing

Capital Market Developments in Asia and LatAm

Australia: placing high importance on trade reporting

China: Shanghai-Hong Kong Stock Connect, provided tax exemption, and increased

QFII quota ($60Bn). China’s “new economy” at Shenzhen is still off-limits

Latin America: Brazil and Mexico are attracting HFT; Mexico is attracting dark pools

Russia: implementing new tech and reg in hope to become a hotbed for HFT

Key Provisions of Markets in Financial Instruments Directive (MiFID II)

Regulate Organized Trading Facilities (OTF)

Safeguard from High Frequency Trading (HFT)

Extend the scope to new products, services, venues, and entities

Improve pre and post market transparency and extend to non-equity markets and to SIs

Extend transaction reporting in terms of frequency, details, and to cover all financial instruments

Stronger investor protection

Reinforce supervisory powers, introduce a stricter framework for non-equity instruments, and gold-plating

Improve corporate governance

Match requirements from cross-border firms.

Clarify the scope of exemptions

Key Reg Initiatives in the USA

Dodd-Frank Act (DFA)

Jumpstart Our Business Startups (JOBS Act)

SEC scrutiny on HFT and Dark Pools

Tick-size pilot program

Key Points of Dodd Frank Act (DFA)

Improved transparency for derivatives which led to SEF

Financial Stability Oversight Council

Overhauls the existing agency oversight system

Tighter rules for securitization and hedge funds

Consumer protection measurements

Increase oversee of credit rating agencies and insurance companies

Volcker rule

Corporate governance and enumeration

Capital requirements

Introduction of Swap Execution Facility (SEF)

Fragmentation: 20 temporary registered SEFs

FCMs have to clear through SEFs, whenever a contract is “made available to trade” (MAT)

Introduction equity-trading methods: algo, SOR, and DMA (dark pools!), though more complex and multi-leg

Need to optimize capital, collateral, and liquidity requirements

FCMs must ensure that their clients’ collaterals are segregated

Exceptions for large notional blocks

Uncertainty with respect to a number of issues (e.g., leverage ratios, cross-border regulatory uncertainty )

A tremendous impact: a transformation from a largely OTC bilateral type of market to a fragmented multilateral trading venues and clearinghouses.

Adaptation by key players (both buy and sell sides)

Centralizing trading floor for all instruments and asset classes

Globalizing big data management

Standardizing performance reporting (TCA)

Engineering new investment products (structural, hybrid notes, and dividend products)

Shortening cycle T+2 or T+0 (reduces risk, streamlines trading, and improves efficiency)

Adopting algo, dark, and SOR by non-equity instruments

Sharp rise in HFT in non-equity markets

Pushing the technological edge in low latency and number crunching (CPU/GPU/FPGA

to achieve nanosecond or millisecond latency)

Dark pools (ATSs) attract flows, since they provide

Price improvement

Lower market impact

Lower transaction cost

Better anti-gaming controls

Improved risk control

Dark pools need to be:

Transparent

Not too big to distort price discovery

Fair and level field (full disclosure, equal access, no change of rules in the middle of the

game)

Dude, where is my order? The proliferation of dark pools :

Fragmented market led to the innovation of Dark Pool Aggregators!

Are dark pools becoming too big?

Declining US HFT

The NYT,

Dark pools under scrutiny

When financial innovation went wrong! 2000- Dot-com crash

2001- Accounting scandals- Enron in 2001 and WorldCom

2002- Investment banks- research payments for recommendations

2003- Mutual funds- market timing and late trading scandal

2004- Insurance companies- bid-rigging

2005- Buy side- inappropriate gifts scandal

2008- Subprime crisis

2008- Tax evasion scandal

2009- Foreclosure crisis

2009- Flash order scandal

2010- Flash crash

2011- Dark pool discussion is heated

2012- LIBOR scandal

2012- Facebook IPO and Knight trading loss scandal

2013- Hash crash

2014- HFT/Dark pools and Flash Boys

Libor scandal leads to Principles for Financial Benchmarks

Published in July 2013 by IOSCO, who was chaired by the heads of UK FCA and US

CFTC

Gives 18 months to comply by benchmark administrators:

Euro Inter-Bank Offer Rate (Euribor)

London Inter-Bank Offer Rate (Libor)

Tokyo Inter-Bank Offer Rate (Tibor)

The three administrators have made significant progress in the implementation

Raised the overall oversight, governance, transparency and accountability of the three

administrators and improved the quality and integrity of the benchmarks

Reverse Engineering!

SEC’s tick size pilot program

IEX: no rebates, no HFT, no liquidity providers, no too many order types, no colo

Higher scrutiny on HFT and dark pools

Potential Financial Innovation in Israel

Algo trading

Dark pools

Smart Order Routers

Pre-IPO exchange

SME trading platform

EM trading desks

Thanks you

Glossary

CSA- Commission Sharing Agreement

DFA - Dodd-Frank Act

DV- Developed Markets

EM- Emerging Markets

ESMA- European Securities and Markets Authority

FCM- Futures Commission Merchants

FIX- Financial Information exchange

FPGA- A field-programmable gate array

FTT- Financial Transactions Tax

HFT- High Frequency Trading

JOBS Act- Jumpstart Our Business Startups

QFII- Qualified Foreign Institutional Investor

OTF- Regulate Organized Trading Facilities

SEF- Swap Execution Facility

Slippery Steve- Stephen Perkins who traded $520M worth of oil futures while causing $1.5 increase in oil prices within minutes

SME- Small and Medium Enterprises

SOR- Smart Order Routers