Forex Network New York 2018 by P&L Services Ltd.

NEW YORK 2018

Contents 4

7 9

Fast Forward: Predicting the Future of Electronic Trading

FX Hedging: Time for a Re-Think?

A Different Kind of Alpha

Are Active FX Funds About to Turn a Corner?

10 Navigating Unchartered Waters 12 Fireside Chat: Keeping Pace With Cryptos

13 US Regulators Shift Attitudes Regarding Cryptocurrencies 15 Exploring the Grey Areas of Crypto Regulation

16 A New Approach to Trading Crypto-Assets

17 The Alchemy of Data

18 Trading in the “New Economy”

19 Cryptos Poised to Go Mainstream

21 What Is the Real Value of Bitcoin?

23 AI - Regular Quants with Bigger Bazookas?

24 Understanding the Limits of AI in Finance

25 Firms Likely to Dominate Markets Using AI

26 The New Reality of Credit

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“Fast Forward: Predicting the Future of Electronic Trading”

L-R: Eddie Wen, MD, Global Head of eCommerce Macro Business, JP Morgan • Vittorio Nuti, Global Head of Segregated FX Execution, Deutsche Bank Moderator: Greg Wood, SVP, Global Industry Operations & Technology, FIA • Matt O’Hara, CEO, 360T Americas • Dmitri Galinov, CEO, FastMatch, Inc

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“FX Hedging: Time for a Re-Think?”

L-R: Chris Solarz, Managing Director, Cliffwater LLC • Momtchil Pojarliev, Deputy Head of Currencies, BNP Paribas Asset Management • Jay Moore, Senior Vice President, Brown Brothers Harriman • Moderator: Galen Stops, Editor, Profit & Loss

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A Different Kind of Alpha Even when implementing passive currency hedging strategies, it’s still important to think in terms of alpha, explained Jay Moore, a senior vice president at Brown Brothers Harriman (BBH), during a panel discussion at the Profit & Loss Forex Network New York conference.

Although this might initially seem to be a contradictory statement, Moore explained that providers of passive hedging services can differentiate themselves both through risk management and what he termed “operational alpha”. While portfolio risk obviously isn’t a concern when implementing passive currency strategies, Moore explained that there is a strong focus on managing other types of risk, such as regulatory risk, operational risk and managing the fiduciary risk that managers have on behalf of the funds that they outsource to firms that are providing the passive hedging. “I think for all of the providers, that’s the common starting point. If you can’t do those things well, the operational risk management side, you shouldn’t be in the business,” he said. But beyond simply providing strong risk management, Moore claimed that firms providing passive currency hedging services can also differentiate themselves by offering operational alpha. “So when you talk about alpha on the active side, you’re talking about boosting alpha. When we talk about operational alpha, we’re talking about preserving returns,” he said. Moore explained that a poorly implemented passive strategy can bleed performance via a variety of implementation issues, such as transaction cost, timing lag, slippage and settlement failures. But these days it is not enough to simply ensure that this doesn’t happen, he said, firms need to offer greater transparency about how the passive hedging strategy was executed in order to demon-

strate to clients that there was not a loss of performance. “Clients want to outsource the process but not the control. So we need to be able to build tools so that ultimately, our clients can have the visibility and the oversight to be able to stand behind their decision to outsource, and that’s where I think the industry in the passive space has lacked for a long time,” Moore added. Of course, demonstrating regular alpha in the form of returns is more straightforward than providing evidence of operational alpha, but Moore said that it is possible to do so via performance attribution. “Performance attribution doesn’t sound so sexy in the passive space, but I assure you it is,” he said. “This has really become a demand in the market, the ability to show clients that when you have an asset that’s denominated in euros but you’re managing it from a US dollar perspective, translating it from euros to dollars has an actual currency effect…the expectation is that the P&L of your hedge should offset that and then any difference needs to be attributable to something related to the implementation of that programme, including and most prominently, the interest rate differential.” Moore added: “But there are other costs involved; transaction costs, making sure that you’re reacting to new information on a regular basis and quickly so that you’re not creating timing lags, or implementation shortfall in other asset classes as it might be known. So having that ability to break down the performance in that way demonstrates that you’re doing your job well and you’re not bleeding alpha, but it also provides a sort of feedback loop into the process because maybe you want to tighten up your hedge ratio filters or widen them out because you’re trading too often. These are the types of things that bring value to clients and preserve alpha.”

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Are Active FX Funds About to Turn a Corner? Despite a decline of investment into actively managed FX funds in recent years, speakers at the Profit & Loss Forex Network New York conference expressed optimism for these funds.

Chris Solarz, a managing director at Cliffwater, a firm that provides investment advisory services, explained that hedge fund strategies in general have struggled to outperform indices since the financial crisis, both on an absolute and relative basis. “Someone mentioned on an earlier panel that it’s not fair to compare hedge fund strategies, hedge fund indices, to the S&P - but in the industry 10 years ago, that’s not at all how we were selling it. We were calling hedge fund strategies equitylike returns with fixed income-like vol, and now it’s been more convenient to say that we have a better Sharpe ratio perhaps than the S&P, and that’s been the picture. We’ve had a dearth of alpha over the past 10 years,” he said. But FX funds actually continued to perform well in the years immediately after the financial crisis, with Solarz pointing out that there were numerous funds with over $1 billion AUM that were producing good alpha during this period. Yet by 2014, one year after the demise of FX Concepts, which was at one time a $14 billion FX fund, active FX returns had become so poor that this was often no longer considered a viable standalone strategy and so much of the FX trading at hedge funds was rolled into discretionary macro funds or CTAs trading across a variety of different asset classes, according to Solarz. There is good news for FX funds though, he said, because while the lack of alpha in the market was largely caused by the coordinated central bank monetary policy that followed the fi-

nancial crisis and led to $10 trillion being injected into the financial system, those policies are now increasingly diverging. “One year from now, that flow in will become an outflow, and at that point we won’t have a heavy hand of government intervention which is distorting the clearing mechanism of markets,” commented Solarz. Partially as a result of this, he expressed optimism that active management could make a comeback within FX, and said that there is still room for currency-specific funds within financial markets today. Momtchil Pojarliev, deputy head of currencies at BNP Paribas Asset Management, agreed with this last point, stating that FX alpha strategies are reliant on volatility, which has been subdued in recent years, but appears to be on the rise once again. “I think alpha is going to come back strongly,” he concluded. Pojarliev suggested that one reason why active currency management has declined in popularity amongst investors in recent years is because some of them have tended to confuse active currency hedging programmes with absolute return - or alpha seeking - strategies. “Part of the reason people have been burnt in FX is that what they bought didn’t meet expectations, because they didn’t know exactly what they were buying,” he said. Pojarliev added: “When you’re talking about FX you have to differentiate between alpha, or FX as an absolute return strategy, which is completely unconstrained and to some extent is basically a truncated version of a global macro…The other thing is actually active hedging, which is a tailored solution for people who have currency exposure and don’t want a passive solution…When you’re talking about performance and the environment, you have to differentiate between those two.”

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“Navigating Unchartered Waters”

L-R: Moderator: Robert Savage, CEO, CCTrack • Alessio de Longis, Portfolio Manager & Macro Strategist, OppenheimerFunds • Kevin Chen, Global Macro Trading/Chief Strategist, Hywin Capital • Evan Brown, Director, Asset Allocation, UBS Asset Management

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Fireside Chat: “Keeping Pace With Cryptos”

L-R: Mike Gill, Chief Of Staff to U.S. Commodity Futures Trading Commission (CFTC) Chairman Christopher Giancarlo and CFTC Chief Operating Officer • Moderator: Galen Stops, Editor, Profit & Loss

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US Regulators Shift Attitudes Regarding Cryptocurrencies Speaking at Profit & Loss Forex Network New York, Mike Gill, chief of staff to US Commodity Futures Trading Commission (CFTC) chairman, Christopher Giancarlo, and the CFTC’s COO, provided a fascinating look at how attitudes towards cryptocurrencies have changed in Washington recently.

Gill revealed that the CFTC received significant criticism within the walls of government last year for its approach to cryptocurrencies, such as bitcoin, which the agency allowed two exchange groups to list futures on at the end of last year. The reason for this criticism, he said, was concerns about money laundering and illicit activity linked to bitcoin and other cryptocurrencies. “When the futures were poised to be listed, we were working with the exchanges to get some more comfort level with their listing and we were spending a lot of time suddenly being advocates for the space because we felt like if we said ‘no’ because we didn’t understand it, then we were just saying ‘no’ to everything, forever,” he said. One argument that Gill said the CFTC presented to the US government is that it would be beneficial for the US to establish itself as the price discovery point for cryptocurrencies, and that to do this, regulation would be needed. “This is what we said at the time: there’s more cotton made in China and there’s more cotton manufactured in China than anywhere else in the world, but the price is made in the US and so US cotton farmers have a huge advantage because they can just hedge their risk in dollars, whereas everyone else has to hedge the risk of their crop, but they also have to hedge their currency risk because they can’t [hedge the crop]

unless they have dollars,” he said. He continued: “So we explained to the government in discussions that if we say ‘no’ just because we don’t understand [cryptos] or we’re not fully comfortable with it, it will migrate at some point somewhere else and there’s a tremendous benefit to US companies and end-users having all these things priced in US dollars.” Gill revealed that he also reminded the US Treasury Department that, rather than the CFTC, it in fact helped bitcoin go mainstream by selling it to the US public. When the Department of Justice (DoJ) seizes illegal drugs, it destroys those drugs. By contrast, pointed out Gill, when the DoJ seized millions of dollars worth of bitcoin after it shut down Silk Road, the US Treasury subsequently sold those bitcoins back to the US public in a series of auctions held in 2014 and 2015. But since last autumn, Gill said that there has been a distinct shift in the regulatory focus regarding cryptocurrencies. “The larger discussions last fall were all about: is this going to disintermediate the US dollar? Will this allow people to avoid sanctions? There are currencies that were created to be like bitcoin, but truly anonymous instead of pseudoanonymous, why exactly do you need that from a regulatory point of view?” he asked. Now, Gill explained, the mood in Washington is more positive. “At some point between the listing and mid-spring there was an acceptance and now they’re looking at this in terms of: what do we need to know about the space and what do we need to be worried about? As opposed to: can we stop it? Should we stop it?”

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Exploring the Grey Areas of Crypto Regulation From a regulatory perspective, one of the challenges around operating in the crypto markets is that different regulators appear to define cryptoassets in different ways.

For example, the Commodity Futures Trading Commission (CFTC) has defined digital currencies as commodities, while the Securities and Exchange Commission (SEC) seems to think that at least some of them might be securities. Speaking at Profit & Loss Forex Network New York, Mike Gill, chief of staff to US CFTC chairman, Christopher Giancarlo, and the CFTC’s COO, discussed some of the challenges facing regulators when it comes to defining these products. Bitcoin, he maintained, still very much fits the CFTC’s description of a commodity. “If you go back to 2015 when the CFTC defined virtual currencies such as bitcoin - and that’s a very important qualifier - as commodities, bitcoin was the main actor at that point and that’s what we were dealing with,” he said, adding, “We never said that all virtual currencies are commodities.” Gill continued: “Bitcoin, in retrospect, in the way it was sort of organically developed without a management, became the perfect commodity for our definition. Bitcoin and the - no pun intended - derivatives of bitcoin such as litecoin, bitcoin cash, I think the definition of a commodity is a comfortable definition for those. When you get to other tokens, that’s where all this grey area starts.”

Despite conceding that there is currently a grey area regarding the regulatory definitions of certain cryptoassets, Gill said that he personally thinks that the areas of potential overlap between the SEC and CFTC are actually very small. However, he warned that within this grey area, the regulatory uncertainty is likely to persist as government agencies simply don’t have the capacity to individually classify all the new crypto products coming to market. “The larger US government is focused on broader issues and doesn’t have the bandwidth to help somebody get their product into regulatory certainty,” said Gill. He also said that, frankly, he’s not sure that the government cares if the regulatory ambiguity regarding certain cryptoassets continues, because the early investors in in these products invest at their own risk. “I’m very supportive of crypto, but this notion that if enough people say this is important that the government is going to stop on a dime and turn around and start fixing things - I haven’t seen it. The timeline for government is much slower than for VCs,” said Gill. But the good news for firms in the crypto space is that Gill predicted that, generally, the regulatory landscape will become more, not less, clear going forward. “We’ll never get the pure Oxford dictionary definition, because no one wants to give up what happens 10 years from now, but I think we’ll get some clarity,” he concluded.

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P&L BURST: “A New Approach to Trading Crypto-Assets”

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Brian Liston, Co-Founder, Seed

Presentation: “The Alchemy of Data”

Ahkit Sahni, Head of Research, ExanteData

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Trading in the “New Economy”

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L-R: Nikhil Kalghatgi, Partner, CoVenture • Sandra Ro, CEO, Global Blockchain Business Council • David Mercer, CEO, LMAX Exchange • Michael Moro, CEO, Genesis Trading • Shaun Cumby, CIO, 3iQ

Cryptos Poised to Go Mainstream

Traditional financial services firms, such as banks, are clearly poised to enter the crypto space, explained speakers at the Profit & Loss Forex Network New York conference.

“Banks are going to make so much damn money off of cryptocurrencies,” said Nikhil Kalghatgi, a partner at CoVenture, a firm that has a multi-strategy asset management platform for cryptoassets. “They're chomping at the bit, laying the pipe right now in order to get connectivity, to answer all the regulator’s questions.” When thinking about the evolution of technology underpinning cryptocurrencies the key question, according Kalghatgi, is whether it has the potential to be an Internet-sized phenomenon. He pointed out that there was a clear gap between when people first heard about about the Internet and then started using it, and that cryptocurrencies could follow a similar adoption trajectory. “Try to think back to when you first got the Internet versus when you first heard about it...So it was probably three or four years before you got your first Internet, the equivalent of you getting your first bitcoin, and then how long did it take before you actually recognised that it was going to change the world? A couple of years later, three or four years later? Well right now, ask yourself if you have a bitcoin and when did you first get it? Dial forward three or four years from then and then you might be able to recognise a time when the average person is going to be able to realise, ‘Wow, this is something major’. We are still years away from that moment for most people,” he said. Meanwhile, Sandra Ro, CEO of the Global Blockchain Business Council, revealed that she

had just been in a series of discussions with European regulators and banks in Brussels and that cryptocurrencies had been a hot topic of conversation. “I was shocked by the number of times blockchain, crypto and AI were actually mentioned by C-suite level executives. It is definitely a top of book conversation,” she said. Ro explained that many of these conversations centred around creating a level playing field, with traditional financial services firms expressing concern that fintech firms are not subject to the same rigorous regulatory requirements as them and therefore have much more freedom to act and operate their businesses. She added that pressure from customers is making it inevitable that these firms are going to enter the crypto space. “Everyone has clients who are demanding they look at this… At the end of the day, if your clients are asking for this, you are doing the work around it and it's just a matter of time whether you decide to launch a trading platform,” said Ro. For Shaun Cumby, CIO at 3iQ, a digital asset investment firm, cryptoassets represent a new asset class and he expects to see them follow a similar path to adoption as credit default swaps (CDS). “Markets evolve. Products evolve. Eventually we're going to see the equivalent of an ISDA group in cryptocurrency, we're going to have standardised contracts, somebody is going going to propose a clearing house. It's just going to become a much more efficient market. And when you have exchanges trading hundreds of millions of dollars a day and taking out 50 to a 100 basis points a day, I mean you just can't ignore the money being made,” he said.

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What Is the Real Value of Bitcoin? There is one question regarding cryptocurrencies, and Bitcoin in particular, that has continued to baffle many, and has caused some skepticism amongst market commentators, namely what is the fundamental value of these assets?

Bitcoin, still by far the largest cryptocurrency that exists, is not a good store of value because the price of a bitcoin is so volatile. As a result, it functions poorly as a currency, after all, no one wants to buy something worth $100 with bitcoins if those same bitcoins are going to be worth $200 a few months later and no one wants to sell an item worth $100 for bitcoins, because those coins could be worth $50 shortly after the transaction. Even as a means of moving funds, bitcoin has been eclipsed by other cryptocurrencies where the network is capable of processing more transactions at a higher speed and without some of the massive energy consumption concerns associated with bitcoin. It’s not necessarily a good store of value, it’s not particularly good for making transactions and there are more efficient options in terms of making payments and moving funds. Which leads back to the question - what is the value of bitcoin? This was a question that speakers attempted to address at the Profit & Loss Forex Network New York conference. “The value of the network, you can argue, is measured in the hash power - that’s the amount of electricity that the miners are putting in to secure the network,” said Michael Moro, CEO of Genesis Trading, a liquidity provider in the crypto markets. “The miners do this at great cost simply because of the financial incentive they have to secure the transactions because of two things: one is the possibility of winning a bitcoin block as a reward for securing the transaction, and two...there's transaction fees, which are the fees that are tacked onto every single bitcoin transmission…The security and the power of the network is imminently tied to the actual value of the token itself. Otherwise, the miners have no financial incentive to do this and I would argue that if the price of bitcoin were much, much lower, then the power of the network

would be that much lower as well.” Sean Cumby, CIO of 3iQ, a cryptoasset investment firm, agreed that the value of these assets lies in the networks that they create. “One analogy I would use is: if you go back 30 years ago, what was the value of wireless spectrum? You had two engineers trying to talk to each other over the airwaves, they weren't even dialing, they were like tuning a big box so that they could secure a transmission. The value was very little when the network was two. Bring us [to] today, what's the value of mobile use spectrum? It's enormous,” he said. Cumby added: “We're really early in all of this. It is going to evolve, just as mobile telephones evolved, just as the Internet evolved, it’s the same thing. We have not yet truly disrupted this massive rent seeking platform of banks and payment systems, but that's literally what this whole technology of Bitcoin, blockchain and crypto is setting out to do…..So there is value in the network, absolutely.” David Mercer, CEO of LMAX Exchange, which recently launched a platform for trading cryptocurrencies, agreed that it’s still early days for crypto trading and cautioned against trying to pigeonhole a market that is still evolving. “I don't have to care about the value of sterling or euros or yen or gold or bitcoin, but people are trading it,” he said. “From a personal perspective, I think it's a very exciting experiment. I have no idea which digital asset is going to win, but we all know that 10, 20 years from now, we're going to be using one or other of these blockchains or probably many of them, but right now I know I have what's becoming a liquid asset class. People want to trade it, FX traders want to trade it.” Mercer continued: “I think the journalists as well have a duty of care to this industry. Do not try and pigeonhole something which is very much at the early stage. The crypto world is far from perfect, it evolves every single day. I, for one, am very excited about LMAX Digital's position in that marketplace to see if we can help it evolve, to see if we can help create efficient, fair, transparent market structure. So I think we all in this room need to embrace it. But frankly, I don't know of any real good store of value in the world.”

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“AI - Regular Quants with Bigger Bazookas?”

L-R: Moderator: Galen Stops, Editor, Profit & Loss • Michael Recce, Chief Data Scientist, Neuberger Berman • Guarav Chakravorty, Co-Founder, qplum • Andrej Rusakov, Co-Founding Partner, Data Capital Management • Richard Rothenberg, Executive Director, Global AI Corp

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Understanding the Limits of AI in Finance Artificial intelligence (AI) and machine learning have become buzzwords in financial services, but while this technology can be applied in finance in numerous ways to improve returns, it also has some significant limitations that market participants should be aware of.

This was the message from speakers at the Profit & Loss Forex Network New York conference, on a panel discussion titled “AI: Regular Quants with a Bigger Bazooka?” “In my mind the biggest problem with machine learning in its application to finance is the problem of non-stationarity. What I mean by that is that you cannot assume that the structure of the data set that you’re using whatever machine learning tools on will remain the same in the future,” said Andrej Rusakov, a partner at Data Capital Management, a hedge fund that uses AI technology to help develop trading strategies. Rusakov explained that the majority of machine learning tools have been built for firms trying to produce more targeted advertising, and of the data sets that they look at and their relationships to one another are very static. The opposite is true in finance, where the data sets that need to be analysed are constantly changing. “The time dimension kills the number of observations, so you can’t really tell Federal Reserve to jack the interest rates up and then go down and then up, or China to devalue its currency and not devalue, just for the purpose of your experimentation. So everything changes all the time, therefore the non-stationarity is a problem and therefore you have to make judgement calls on how to patch different times together and make inferences from them,” said Rusakov. Michael Recce, the chief data scientist at Neuberger Berman, agreed that stationarity issues are one of the main reasons why AI tools fail to yield positive results when applied to finance.

Talking about how AI is being used in advertising, Recce said that the types of data analytics being used by advertising firms are also applicable to finance and, as a result, he expects there to be an influx of human talent from this industry into financial services. “That exact analysis that they’re doing for showing you the ad is the analysis they have to do to understand who is winning in the marketplace and to, for example, predict an earnings surprise,” he added. Recce also pointed out that some firms are trying to apply AI and machine learning tools to problems where they are not needed. “If you can’t solve a problem, don’t ask a machine to solve it, and definitely don’t ask a machine to solve it by throwing tons of data at it,” he said. “Machine learning tools are all too often seen as the go-to direction and the thing that will solve [any problem] no matter what.” Richard Rothenberg, executive director at Global AI Corp, concurred with this last point, stating: “When we think of AI, it’s a way to augment or enhance what you’re already doing. So part of our process is to do as much as you can with traditional methods and, if you see something there, AI can probably help you do things faster and sometimes more efficiently, but it’s not the ultimate answer. You need a lot of skepticism to deal with all the data mining and over-fitting and all the wrong signals and false positives that may arise.” The other major challenge for applying AI to finance that was highlighted on the panel was just the sheer investment that firms need to make in order to use this technology in an effective manner. “It’s not easy, it takes a lot of investment, investment in skill set and technology investment,” said Gaurav Chakravorty, co-founder of qplum and a former partner at Tower Research Capital. He added: “There are so many ways you can go wrong with the technology, it’s an approach and you can use it incorrectly, that’s a limitation. A lot of people are not going to adopt it because it’s a sea change from their current workflow.”

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Firms Likely to Dominate Markets Using AI The increasing use of AI technology is likely to create incumbent firms that dominate markets, said panellists at the Profit & Loss Forex Network New York conference. However, they also said it might not be the biggest firms in the markets today that become these incumbents.

“I think [AI] is changing the landscape quite a bit,” said Andrej Rusakov, a partner at Data Capital Management, a hedge fund that uses AI tools to develop trading strategies. “People who are missing the wave are going to be left behind, I don’t think there’s any question about it. I think that human day traders will be wiped out, if they’re not already.” He added: “What’s happening is disruption from the lower ends. You start with short-term forecasting and then you move up the value chain to making longer-term bets and longer-term predictions. So it is redistributing the way that money is being managed and more of it is going into quantitative firms with novel approaches.” Rusakov also pointed out that the barriers to entry are falling for firms wanting to make use of AI technology within financial services. This is because the cost of computing power and data storage is cheaper than it has ever been, and firms no longer need to make massive investments in hardware to scale up their businesses. However, Richard Rothenberg, executive director at Global AI Corp, countered this last point by claiming that the cost of data and the complexity of the data needing to be sifted through to provide value to financial services firms, has increased. “This may actually lead to a concentration of not only resources, but capabilities and a reduced number of participants, in a very similar way that happened in the HFT growth days

where you went from hundreds of participants - many of them going broke like Knight Capital - to suddenly where we have less than 10 who control 90% of market liquidity,” he said. Indeed, Michael Recce, the chief data scientist at Neuberger Berman, predicted that firms using the right technology will come to dominate and have 80% of the markets that they trade, but also said that the “winners” in these markets are not necessarily the largest firms in the market today. “The point is, there’s going to be a complete turnover, because lots of the firms that aren’t using this [technology], no matter how much they spend they’re going to end up with the wrong people, the wrong data and the wrong process, because they’re too top down in their decision process. There will be winners but it’s not necessarily the people who are winners currently, it’s going to be a new set of winners,” he said. Gaurav Chakravorty, co-founder of qplum and a former partner at Tower Research Capital, agreed with these comments and added that the use of AI tools will mean that the eventual incumbents will continue growing in size: “In financial services, if you have a firm that is bigger, cheaper and makes money most of the time, everyone will migrate to using them.” However, he did point out that there is a lot of hype around AI in financial services right now, and that this is disproportionate to the actual use cases for this technology currently being implemented. As an example of this, he recounted a story about an allocater who recently asked a hedge fund manager if they use AI, only for the manager to reply that they do and then push a 25-year-old analyst in front of the allocater as proof of this. “Currently in financial services, we are talking a lot about AI, but practically no one is using it,” he concluded.

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“The New Reality of Credit”

L-R: Rosario Ingargiola, Founder and CEO, OTC Exchange • Andrew Ralich, CEO, oneZero Financial Systems • Paul Houston, Executive Director, Global Head of FX, CME Group • Sanjay Madgavkar, Managing Director, Global Head of FXPB, Citi

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