THE "BURSA" CONFERENCE ON THE CAPITAL MARKET "Investors hold the most important role in the capital markets"

Reporter: What is the most developed financial market in the world and what are its distinctive features?

Andre Cappon: The United States of America represent the most important financial market, the biggest and most liquid in the world. At the same time, it is a very complicated and fragmented market, far different from the market of other countries. In the US we do not have just one exchange, as is the case in Romania, there are in fact about 13, about 30 something automated trading systems, the so-called "dark pools" (ed. note: automated trading system), we have a number of companies that are market makers, meaning they provide liquidity to the financial market. Brokers have the option to direct the orders to certain spots based on liquidity, the amount paid (ed. note: maker-taker) and other factory. In essence, the US represents a multipolar market because there are numerous liquidity poles and because it is very fragmented. Also, there are several different regulators. We have a regulator in the Securities and Exchange Commission (SCC), another regulator in the Federal Reserve, state level regulators, as well as Commodity Futures Trading Commission (CFTC) for futures. At the same time, the United States have the most competitive financial system in the world.

That means that there is a constant battle that is taking place in the market and that makes it that prices (ed. note for services) and the brokers' revenues are constantly under pressure. For instance, over the last ten years, the fees of active funds have fallen by half. As for brokerage fees, twenty years ago, the fee was five cents per share. Currently, a full service broker will charge 2 cents a share.

It doesn't seem that terrible, half of the intermediaries' income was lost, but in direct market access (ed. note: DMA, electronic facilities which allow investors to trade directly, with low supervision by brokers) the brokerage fee is 0.5 cents per share. So that the intermediaries are paid increasingly less and are under a constant pressure.

Reporter: Do you think we are on the threshold of a new development that comes with the new technology...

Andre Cappon: Technology is the most important support in a financial market. Technology provides the means of communication between traders (ed. note: people who want to negotiate), meaning between investors, buyers or sellers. If we think of traders, how has the situation evolved? More than a hundred years ago, the financial markets were in the street. The New York Stock Exchange started out under a tree on Wall Street. That's where people who wanted to buy and sell shares, government bonds and so on. Everything was happening in a crowd through a method which is still called "open outcry", meaning everybody would scream to sell and buy. Then we have gone to a centralized market, we have moved to the negotiating floor (ed. note: the ring), and over there orders would come in by phone, fax and courier, and thus we have created the figure of the agent of a trader, which is called a broker. The broker represents a trader, who is their customer. That was the classic system. After that, in the 1980s, and 1990s respectively, we have moved almost completely to electronic negotiation. Brokers lost most of their function, and now everything is happening at the exchange, at the depository and at the central institutions, electronically. The broker still exists, but has a more limited role. But in the future, through the internet, blockchain, smart contracts (ed. note: computerized protocol which digitally facilitates, verifies or imposes the negotiation and the honoring of a contract respectively, without a third party) and with security tokens (ed. note: a series of digital codes which represent financial assets such a shares, bonds, voting rights and so on), which are the new emerging technologies, I think that everything will change. Further in the past, many years ago, we had the bilateral negotiation. Meaning a seller would talk to a buyer and then the settlement would be done bilaterally. Someone would bring in the shares and would receive a check. Currently, we have moved to central institutions. We have various platforms such as exchanges, automated trading systems, inter-dealer brokers (ed. note: who facilitate the transactions between financial institutions, "dealers" which can be found particularly in the fixed income markets). We have central market infrastructures which are the settlement houses and the depository, which work very well, but I think that in the future we will increasingly see a multilateral and decentralized market structure.

Reporter: What is the hierarchy of the players on a financial market (the one in the United States)?

Andre Cappon: Currently, investors hold the most important part in the capital markets, as they are the final customers of the financial market. They pay all the fees to the asset managers and to the intermediaries for the sThey pay all the fees to the asset managers and to the intermediaries for the services they receive. Secondarily, we have what is called the buy-side (ed. note: the party which makes acquisitions) or the asset managers, which handle the funds entrusted by these investors. Then we have other intermediaries, the so-called sell-side, who act as agents for the investor. Then we have the dealers, who act as counterparty, conducting a negotiation where they hop to make money off the "spread", or profit margin, instead of on commission.

When it comes to market infrastructures, we have first of all the exchanges, the so-called "inter-dealer brokers", intermediaries who act between dealers, who get entrusted orders by various dealers. Then we have market data services (ed. note: offer market information), such as Bloomberg, Reuters and others. We have a clearing house (ed. note: settlement house) which goes in between, custodian banks, certain banks that handle the management of their customers' portfolios, and lastly, all the securities are registered with a depository. We still have a very important infrastructure, represented by systems providers, namely the technology suppliers. So we have a large number of various actors who provide various services.

Reporter: Investors play the central part, but what has happened to the intermediary?

Andre Cappon: As I was saying, investors are the end-customers of the market, and the intermediaries then play various roles, such as protecting the investors' anonymity, so that when they want to negotiate it is confidential whether they are looking to buy or sell, which could influence the price. Another role of the intermediary is to provide liquidity through a central market, meaning the exchange, where we have a central limit order book (ed. note: CLOB), the device whereby the exchange presents the orders. To supply liquidity when it acts as a market maker or dealer, to be a reliable counterparty and a central registry of good faith, and perhaps the most important function is to advise the investor concerning the picking of the investment strategy and to supply information about the market. These are the classic roles of the intermediaries. But over the last 20 years, many things have happened. For example, in the United States about 20% of the brokers have disappeared, whereas in Brazil approximately 80% of them have gone away, and the same has happened in Romania, compared to the early days of the market.

Another thing that has happened with the intermediaries is that their roles have begun to blur and merge. For instance, we currently have a large number of "dark pools", which are in fact exchanges which are not as transparent as a classic exchange and which often are dependent on a bank. Today, the biggest "dark pool" is UBS (ed. note: the bank was fined in 2015 by the SEc for failing to comply with the regulations concerning order execution) in New York, where the turnover is a lot higher than on many American exchanges. Also, over the last 20 years, the exchanges and the inter-dealer brokers have demutualized, privatized and consolidated meaning that their roles have begun to overlap as well. Another development over the last few years is that the classic liquidity providers, market makers, are increasingly fewer. We now have a large number of players who carry out this role, such as hedge funds, "market maker firms" like Citadel or Virtu, high frequency traders and algorithmic traders.

Reporter: What will we have in the future at this intersection of liquidity providers/?

Andre Cappon: I think that we are going to see "liquidity networks" and settlement in T+0 DVP (ed. note: delivery versus payment). These two manners of operation will become possible in the future. As for the "liquidity network", I am going to quote a very interesting article, which is going to be presented at NY University in a few days, about how liquidity on the financial markets is generated. This article allows the visualization and representation of the connections between brokers and investors. It is noticeable in a representation that some brokers are closer to the center (ed. note: a fundamental concept in network theory), and they have relations with more important customers, while others are more isolated, which means that they work with a low number of customers. That represents a snapshot of liquidity in a financial market at the current time. I think that the roles of brokers and investors will overlap in the future, that we won't be having certain brokers which are going to have a privileged role, meaning that they will be receiving or generating more liquidity than others, but rather, that we will have a liquidity network in which everybody will participate, in which the intention to buy and sell is announced and where everybody will be able to tell what kind of investor they are and what they are looking for, while the rest is achieved through technology.

Reporter: How do you see the evolution of the products?

Andre Cappon: Indeed, another thing that will be possible with the new technologies is a change in the nature of the traded products. In the present world, as well as in the past, products are standardized. We have listed futures contracts, instead of OTC forwards (ed. note: over the counter, which allow the personalization of the contracts), various products such as ETFs on the exchange and so on. We are standardizing the products for a very important reason: we want to have more liquidity. If the product is standardized and everyone understands it, then more people will buy it and sell it. This standardization is good as it generates liquidity, but it also creates a basis risk for investors. If I am a pension fund and I want to have a guaranteed return of at least 3% a year, and with an upside potential, I currently have to create that return through the combination of various standard instruments. In the future, through the intelligent contracts completely customizable products will be possible, so the need to have standard products will decrease, and the basis risk will also decrease a lot. For instance, a pension fund that will want to have exposure to commodities in South America will achieve a direct negotiation with a pension fund over there. All of these things will be possible with the new technology.

Reporter: How will the financial markets function in the future?

Andre Cappon: There is a trinity of values: "liquidity, transparency, security". We want to have liquidity, transparency and security in the settlement of trades. Liquidity is the possibility of finding a counterparty quickly, without a significant "market impact". As I've said, years ago liquidity was provided mostly by the brokers, by the sell-side. Over the last few years, as brokers and banks have suffered greatly from the decisions of the regulators, they have significantly reduced their market-maker abilities, so their liquidity has become difficult on many markets in America and Europe.

With the new technologies we will have access to those liquidity networks which will connect various investors, intermediaries and liquidity suppliers, so that the whole liquidity will undergo a transformation. It won't be something that will be generated on the exchange and by the market makers exclusively, but rather everywhere and by every market participant.

As for where transparency is concerned, classically, the exchanges communicate the transactions executed, and the OTC markets have increasingly stringent reporting rules, while the negotiation intentions are shown through the CLOB structures on the exchange. In the world of the future, we may have different levels of transparency. For instance, a trader can announce their interest in a certain security, they can say whether they are a buyer or a seller, whether they are interested in a big block or in just 500 shares. They can also say what kind of counterparty they are. If they are a "sophisticated investor" or a "qualified investor" (ed. note: classifications granted to investors depending on their capital and experience) and so on. Transparency will therefore be multidimensional, not just apply to what is being reported on the stock exchange. Every negotiation intention will be presented. As for the clearing and settlement, we currently have a 3-day delay between the negotiation and the settlement, in other words T+3. In the case of derivatives we have "daily mark to market" and "margin calls". In the beginning we had bilateral settlement. There are currently still a few markets (ed. note: for example Peru) where the settlement is still done bilaterally, meaning a broker that has sold shares needs to send someone with a block of shares and in three days that person needs to get a check. Then we have switched to the central counterparty and depository model, this being the dominant system in the world at the moment. In the future, thanks to the blockchain technology and to smart contracts, we will be able to perform settlement bilaterally and T+0, meaning at the moment of the negotiation. Central infrastructures will still have a part to play, but it won't be that important. A large number of new products will thus be negotiated bilaterally and in T+0.

Reporter: What will be the regulators' role?

Andre Cappon: They exist to protect investors, to stop market manipulation and insider trading. In the future, I think that the regulators will be concerned with more advanced things, such as eliminating monopolies in the industry to the benefit of the markets and of investors, to reduce systemic risk when it comes to settlement and market concentration.

Reporter: Where will this change happen for the first time?

Andre Cappon: It will happen in the crypto world. Everybody is already familiar with crypto: we have the blockchain and smart contracts which allow us to do a large number of things which weren't possible before. There is a new technology which has become very commonplace recently, namely tokens. A token is a digital asset which is stored in the blockchain and which can be assigned through an electronic wallet and even on the stock market. We have three types of tokens: payment token, which is a digital currency just like bitcoin, we have utility token, for instance airplane tickets, and last but not least there is the security token category, a series of digital codes which represent a financial asset such as a share, bond, option, a real estate asset and so on, which is attached to a cryptographic symbol. Security tokens can be recorded by a blockchain just like a share is recorded at the depository. This provides huge advantages in terms of efficiency, and negotiations will be performed far quicker, without intermediaries. More liquidity will be generated because you will be able to talk to any person in the world who owns a computer. I think that we are going to see an increasing number of partnerships between the traditional exchanges and the token platforms.

Reporter: A conclusion?

Andre Cappon: I think that we are evolving from a central architecture in the financial markets to a multilateral, multipolar, architecture. Disintermediation will continue, in every banking and financial activity. Fintechs will be increasingly relevant competitors to the existing institutions. The revolution will first take place in the crypto world, and intermediaries will earn less and less, meaning that they will have to reorient themselves towards services with higher value, such as financial consulting. Could Romania become a leader in fintechs and cryptos? Estonia succeeded. Why not Romania?

Reporter: Thank you!