London Summit 2015 - The Future of Finance: Strategies for a Fast-Changing Industry (I)

Technology as a Transformative Force

• Nobel Gulati (Two Sigma Advisors) characterizes the current era as an "information revolution" comparable to, yet potentially more profound than, the Industrial Revolution.
• Drivers of this shift include exponential growth in computational power, advancements in machine learning (speech, natural language processing, vision), and the democratization of information allowing billions to contribute data.
• Two Sigma, founded in 2001, employs 850 people, two-thirds of whom are scientists and engineers, managing $28 billion for institutional investors to find value in global data.
• Gulati argues finance is uniquely impacted by this revolution because the industry is fundamentally about information processing.

Disintermediation and Consumer Lending

• Dominic Lester (Jefferies) notes technology companies are layering value-added services over the "utility" of traditional banking deposits, disrupting lucrative areas like remittances and foreign exchange spreads.
• Emerging technology enables real-time card issuance and policy controls for families, potentially eroding traditional bank margins derived from overdraft fees and short-term lending.
• Peer-to-peer lending is expanding in emerging markets where traditional credit scoring is absent; for example, China has 500 million emerging middle-class individuals with mobile access but no credit history.
• Partnerships between Chinese tech giants (Tencent, Baidu) and lenders (China Rapid Finance) utilize big data (e.g., social media behavior, purchase decisiveness) to pre-approve credit for unbanked populations.
• Lester highlights that technology is shifting credit assessment from purely ability-to-pay to character assessment traits derived from digital footprints.

Market Automation and Liquidity Crises

• Seth Merrin (LiquidNet Holdings) asserts that technology has automated equity block trading, replacing the human intermediaries previously relied upon by institutions like Goldman Sachs.
• The corporate bond market remains largely manual despite a 10-year doubling in market size and massive inflows into bond funds.
• Regulatory capital requirements have reduced bank facilitation capital for bond trading from $250 billion to approximately $15 billion, creating a liquidity crisis if interest rates rise.
• LiquidNet is connecting 800 of the world's largest asset managers to trade corporate bonds electronically, addressing the gap left by reduced bank liquidity.

Regulatory Challenges and Systemic Risk

• William White (OECD) warns that regulators have historically failed to keep pace with innovation, citing the pre-2008 crisis failure to identify "shadow banking" terms.
• White argues the financial system is a "complex adaptive system" where future outcomes are inherently unpredictable, necessitating a shift from maximizing productivity to "minimax" strategies that prevent catastrophic failures.
• Current global debt levels are 20 percentage points of GDP higher than in 2007, with 50% of this increase occurring in emerging markets, suggesting significant future debt restructuring is likely.
• Nobel Gulati advocates for principle-based regulation over prescriptive rules, urging regulators to assess risks proactively every six months in partnership with market participants.
• Gulati cautions that blaming technology for market instability (e.g., flash crashes) often overlooks human risk, noting that technology can also reduce overall risk if managed correctly.

Flash Crashes and High-Frequency Trading (HFT)

• Seth Merrin distinguishes between illegal front-running (pre-empting large orders) and legal HFT strategies that exploit supply-demand imbalances via algorithms.
• Merrin argues HFT exacerbated the 2010 Flash Crash because machines reacted to a "fat finger" error in S&P futures, amplifying liquidity gaps.
• Merrin criticizes the SEC for being slow to react to technological risks, noting it took years to implement mitigation plans after the initial crash.
• Gulati suggests that regulatory silos (banks vs. brokers vs. traders) are artificial; technology is creating a uniform global platform that reconstructs market roles based on natural strengths like capital provision or liquidity.

Global Innovation Hubs and Emerging Markets

• Technology is enabling financial inclusion in emerging markets by bypassing legacy infrastructure; M-Pesa in Africa allows mobile payments without traditional bank accounts.
• In rural India, mobile technology allows farmers to bypass local intermediaries and access transparent market pricing, disrupting local monopoly profits.
• Non-bank entities (telecoms, tech giants like Alibaba, Tencent, Apple) are becoming major financial players, offering money market funds and credit scoring in the absence of traditional banking.
• Nobel Gulati points to insurance as the next frontier for data science application, noting the industry is currently in the "dark ages" regarding pricing and processing automation.
• Dominic Lester observes that while Europe faces complex regulations, it is a hotspot for fintech innovation (e.g., Wonga, Funding Circle, TransferWise), though scaling may be harder than in the US or China due to smaller, fragmented markets.

Market Structure and Moral Hazard

• William White warns that the relentless search for efficiency has increased systemic leverage, creating a tightly wound system with little slack that can lead to disasters when combined with other efficiency gains (e.g., easy monetary policy).
• Lester estimates that out of 500+ online lending platforms, approximately 495 are likely to fail, predicting consolidation where banks acquire successful tech firms to lower lending costs.
• The panel agrees that disintermediation is inevitable, as consumers (especially millennials) prefer digital experiences over traditional banking interactions.
• Some complexity requires human intervention; Alexandra Altinger (Sandair Multifamily Office) notes that intricate value chains (e.g., mortgage securitization) still require human due diligence and robust regulation.
• Gulati contends that financial institutions must decide whether to remain vertically integrated or divest into specialized functions (e.g., distribution vs. management) as technology forces market efficiency.