Financial Presentaton
Financial Presentaton

The Age of Global Markets and the Global Investor

Keynote for Ken Griffin, CEO Citadel Investment Group
25th International SFOA Bürgenstock Conference
The International Forum for Derivative Markets

Thank you HOST NAME, and thank you for having me here at what has become a very distinguished gathering recognized around the world. I’m honored to be a part of it. This is a wonderful conference in a beautiful place – a perfect setting for us to sit back and think about the future of our industry and the future of the world’s capital markets.

Every few decades a new technology comes along that reshapes entire industries, and even changes society. We’ve seen it going back to the advent of the telegraph, electricity, the automobile, and more recently, the computer and the Internet. All ushered in new, efficient ways of doing things, upsetting the status quo, creating new opportunities, and changing the way we work and live.

We’re looking at equally compelling forces reshaping our industry. Indeed, we have watched technology reshape our markets for well over a decade. Today we are moving towards a watershed moment in the transformation of capital markets.

It is a remarkable time. We are heading toward a new era. One in which all exchanges are faster, freer, richer, more transparent, and global in nature. It is an evolution we should be cheering. The impact of technology and competition in our industry will be positive for customers, for the market--and ultimately, for all of us.

Jim McNulty, a good friend and the former leader of the Chicago Mercantile Exchange, put it best when he said: “Better marketplaces will create a better world.” That ought to be our guiding principle – and that is really the thesis of my brief remarks this afternoon.

The Message Today

My argument is simple and threefold:

First, the future is here. Despite barriers, technology and the drive toward electronic trading will continue to reshape the market and exchanges, driving efficiencies, weeding out marginal players. The decline of floor based markets, reduction in regulations and spread of innovative electronic markets should be embraced.

Second, new opportunities will arise in the new market. Look for a global change in the market structure. We will see much more competition and repositioning among the exchanges in this new global market structure. But there will be plenty of opportunities for those who are bold and position themselves correctly.

Finally, despite much speculation, there won’t be one, single global market. But there will be global investors. An investor enabled by better technology, with access to more information about prices. Today I want to explain why serving the needs of that global investor in the new electronic age has to be the exchanges’ highest priority.

Citadel as a global thought leader

Before we begin, I would like to say a couple words about Citadel, since my experience has largely shaped my views of what would be best for the future of our industry. As some of you may know, I started in this business making trades from my dorm room at Harvard. We’ve grown a little since. We now employ a team of approximately 800 professionals and staff. We’re based in Chicago, with offices in NY, SF, London and Tokyo.

Today we manage $11 billion of investor capital using a variety of relative value, event-driven and fundamental investment strategies. Our primary trading strategies currently include convertible bond arbitrage, statistical equity arbitrage, fixed income investing, mortgage-backed trading, global event-driven investing, and fundamental equity investing. We also make investments in merger arbitrage situations and distressed securities. In addition, Citadel is a leading market maker of listed equity options.

We think of ourselves not as simply another hedge fund, but as complete player and customer in the market. We do business 24 hours a day because we are engaged in markets and financial products in every part of the globe. That experience has given my colleagues and I some valuable insights about how markets and exchanges ought to function and serve the customer

At bottom, we believe that the goal of exchanges should be building a marketplace that spreads prosperity and helps investors grow wealth. As a substantial buy-side investor in the global financial markets, Citadel has a vital interest in the development of fair, efficient, transparent and liquid financial markets. Not just because it is good for our business, but because ultimately healthier markets both strengthen investor confidence and reduce the cost of capital.

Global Market Changes and the March Toward Electronic Trading

Now, let’s talk about my first point: the inevitable march toward electronic markets and a new market structure, one based on global oriented, transparent, competitive forces.

On this point, I am preaching to the choir. European markets are already ahead of the rest of the US since you embraced electronic markets years ago. As you know, the arguments for electronic trading are compelling. Electronic markets have less “friction.” Trading is easier, faster, more efficient, more transparent. Electronic markets make it easier for investors by providing more information more quickly.

In this world, the floor-based, manual system with its fleet of specialists at the New York Stock Exchange is an anachronism. I believe the only places that cling to the floor-based market are Nairobi, Buenos Aires, and New York [check]. But because New York is so dominant, it has held up progress on the global front. At $9 trillion in annual volume, it is larger than the next nine exchanges combined.

Fortunately, the ice is cracking. The NYSE is making its first, hesitant steps toward electronic trading. And in Washington, the Securities and Exchange Commission is considering the usefulness of the outdated “trade through” rule.

This is a vital debate. The trade through rule, as many of you know, prohibits a trade in one market at a price inferior to the price quoted in another market. While this rule may have been justified in a world dominate by manual markets, it’s unnecessary in today’s automated markets.

I believe that the true choice faced by investors today is not a choice between speed and price. It’s between speed and certainty of execution of an electronic market versus delay and uncertainty on a manual market.

In my experience, manual markets are inefficient, prone to “phantom quotes” and slower and less reliable than electronic markets. Investors, of course, pay the price.

That is why Citadel recommended that the SEC completely eliminate this trade through rule and rely on robust competition and best execution practices

Let me offer just one illustration of how speed can actually be more valuable to customers. At Citadel, we estimate that the theoretical value of what we call an “execution option” – the 30-second option to execute an immediately executable order—equals about 0.3 cents a share for a typical S&P 500 stock. Over 12 months, the estimated cost came to over $750 million [cost to whom?]. But the cost to investors in lost opportunities is much larger.

Electronic markets, of course, provide nearly instantaneous fills for investors, eliminating the execution option. It is simply a more efficient system that benefits the investor.

The efficiencies of the electronic system can be seen in how much easier it has become to trade on electronic exchanges versus the New York Stock Exchange. Since the Chicago Board of Trade went to an electronic system a few years ago, the total volume soared. And if you compare stocks listed on the NYSE with comparable stocks listed on Nasdaq, you’ll find the Nasdaq-listed companies with consistently higher volume. Dell’s volume is always higher than HP. Microsoft’s is always higher IBMs. Electronic markets create less friction – and as a result, encourage trading.

I also believe that markets should be modernized in other ways. Too often our exchanges and market players rely on internalization and access fees to generate revenue. Both are bad business models, and should be eliminated. Hidden access fees, charged to investors by certain electronic communication networks, impede price transparency and discovery. While small, they still often add significant non-transparent costs to securities transactions. This effectively hinders transparency and distorts the market. And that is not good for the investor we want to be encouraging.

The good news is that I believe that in our lifetimes, we will see the last of the floor-based markets fall. The future will be guided, as it has been in Europe, by efficient markets, robust price discovery, transparency, depth, and investor choice.

New Market Structures and New Opportunities

That leads me to my second point: I believe this new era will open up new opportunities. It will be good for investors—and good for the exchanges who seize those opportunities.

As I mentioned, the new marketplace will be more transparent, faster, and more efficient. This will fuel a reorganization of global markets, and more competition and repositioning among the exchanges. We should welcome and promote these developments.

What we have already begun to see is that as exchanges evolve from mutual organizations into professional, for-profit, well managed, entrepreneurial organizations, they can become much more innovative. The opportunities lie in developing new products and services for customers.

In the past, the notion that there would be more competition among exchanges was seen as a possible threat. But in an age of electronic information, this isn’t a zero sum game. We know from experience electronic trading and other global investor services will attract or ”create” investment. And that is how the exchanges themselves should treat this new world.

There are going to be more connected customers and more sophisticated investors around the world. Smart exchanges will operate, in a way, like internet entrepreurs: finding niche markets, using information to improve customer experience, creating products that can be accessed electronically by investors regardless of where they work or live. As Ben Steil, a senior fellow at the Council on Foreign Relations Observed, in this new market, “the network is the market.”
That means a shift away from regulators. We’ll have a chance to rewrite the value chain so exchanges—not regulators or middlemen—can spread the risk and deal directly with the investor. The result is you’ll see more potential capital flowing into markets and new revenue as regulatory hurdles are torn down.

What kind of new revenue generators can markets pursue? Perhaps the model for the creation of new proprietary products is the STOXX index. STOXX has been an invaluable addition to the market place and I believe that there could be new indices and similar information-driven products created in the future.

Similarly, I think exchanges should be using this period to create new ways to enter the swap market. This has been tried unsuccessfully before, but that was largely because the incentives of the major players were not aligned. The key will be listening to the needs of customers -- customers, in fact, like us – to see whether a new, less risk-averse system for swaps can be developed.

I also see an opportunity for new innovations in clearing – a problem that is desperately in search of a solution. For too long we have relied exclusively on regulators to establish clearing solutions. At this point we should be asking whether a sufficiently bold exchange could emerge with new ideas.

At the same time, many exchanges might seek out new partners. I think it is entirely possible, For instance, that we could see alliances between exchanges and information providers such as Reuters or Bloomberg. We now have the technology to bring financial information in real time right to the desk top. Surely there is an opportunity for exchanges to bring the trading and decision making functions to use this same technology to create more efficiency for their customers.

Finally, I think it is safe to predict that we will see more cross border alliances, where exchanges maintain local presences but are linked together to provide international trading capabilities. Singapore and Australia are examples. They provide access to each other’s stocks. London and Johannesburg exchanges are also linked. These alliances have made the world more connected, more efficient, and more interesting.

But the ultimate challenge is for the exchanges themselves to become the true entrepreneurs and innovators. In that sense, I think we are living at one of the most exciting times for the global capital markets.

The Big Picture: Richer Global Markets

That raises third point I mentioned at the outset. What will our capital markets look like? Will there be a single, global capital market? I know that we are soon to have a panel discussion on that fascinating topic. But let me set the stage for that discussion, as it were, by offering my perspective.

The idea of a single, global market has been around well before 2000 with the failed merger attempt of the London Stock Exchange and Frankfurt's Deutsche Börse Exchange. But as technology enhances, the question remains whether we will see more consolidation – perhaps just one global exchange.

The idea of a single, seamless, global market is superficially appealing—but ultimately misguided.

I am confident in predicting that there won’t be one enormous global market because it’s inefficient. It doesn’t work for the same reason you don’t have one global “SuperStore” selling everything. People like going to shopping malls, but once inside the mall, they like the ability to visit the vendors that cater to their needs.

Similarly, in the United States we have Office Depot for office supplies and Home Depot for hardware and lumber. Two huge, highly efficient stores. But no one would ever suggest merging the two. The results would simply be too large, too confusing, too inefficient, and too cumbersome for customers.

In the financial industry, there will always be some consolidation, but it has limits. The failure of consolidation in Europe is simply a reminder that it is hard to make mergers successful in any business. Yes, someday we will see more cross-border consolidations of exchanges, perhaps solving the currency differences. But that is not a project for the exchanges themselves. Today, the world of multiple markets is the most efficient for investors, and serving those investors is where exchanges ought to focus their energies.

In fact, in our own industry, we have seen the pitfalls of over-centralization and lack of competition. Not long ago, the Treasuries market was dominated by a single, New York firm: Cantor Fitzgerald. They had an electronic platform for trading called Espeed, and 90 percent of the market in trading. It was the only game in town. But as so often happens with virtual monopolies, it became less sensitive to the needs of its own customers.

In response, a consortium of brokers eventually created an alternative, Broker Tech. Each of the contributors committed to keeping a certain volume of their trade through Broker Tech so that it could become a viable alternative. The result is that competition created a more vibrant market in Treasuries trading. BrokerTech now has over 50% of the market, fees have come down for investors, and competition with Espeed remains vigorous.

There have been other innovations that take advantage of the expanding market place and electronic trading technology. iONTrading, sells software products and services to help fixed income traders manage trading activities on electronic income markets. It has helped revolutionize trading for customers who want to be active in markets around the world by making trading as efficient and seamless as possible.

The result of these and other innovations is not a single, centralized, tightly controlled global market. Instead it is a fragmented market, full of competition, but made far more accessible by advances in information and trading technology.

Conclusion: We believe this will all lead to better markets, and a better world.

So to conclude, I think all of us should welcome the age of globalization and all its consequences for our industry.

Everyone benefits from electronic markets, and globalization. Electronic markets level the playing field for all investors, and fosters a more efficient, fairer, and more vibrant market. And studies show that globalization helps improve overall financial systems through two main channels: by increasing the availability of funds and by improving the financial infrastructure. Globalization will lead to deeper, more stable, and better regulated markets.

It’s up to us to help shape this new world. We can help by reducing regulations. We can help by embracing the new technology and managing more efficiently. And we can help by using our creativity to serve the global investor in new ways.

Despite all the advances in technology, I believe it is still individual leaders, entrepreneurs, and innovators that will help lead investors through this new world.

Forty years ago, John F. Kennedy said “Man is still the most extraordinary computer of all.” In this age of man, markets, and machines, I believe man is still the indispensable factor. And that is what makes it so exciting to be in this business.

Thank you for your time and your invitation here today. I’d welcome your questions.
Ken Griffin is Founder, President and Chief Executive Officer of Citadel Investment Group, L.L.C. Founded in 1990 by Mr. Griffin, today Citadel has approximately 750 employees, with offices in Chicago, London, New York, San Francisco and Tokyo. The firm currently manages nearly $11 billion of investment capital in two domestic and two offshore funds. Citadel’s investors include leading endowments, foundations, families of wealth, international money center banks, insurance companies, pension plans and Wall Street firms.