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Daniel Gorfine
Adjunct Fellow; Vice President, External Affairs and Associate General Counsel, OnDeck
Capital Access and Capital Markets and Demographics and FinTech and Global Economy and Public Policy
Daniel Gorfine is an adjunct fellow at the Milken Institute and vice president, external affairs and associate general counsel at OnDeck, a technology-based company focused on transforming small business lending.
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The evolution of technology and markets

By: Daniel Gorfine
October 01, 2013
   
   

Global and domestic markets are evolving rapidly in the face of technological, structural, and regulatory change. A number of key themes have emerged at the intersection of technology and finance, affecting everything from trading practices on Wall Street to online payments to financing startups. Here a few key trends weaEUR(TM)ve identified, many of which featured prominently at the Milken Institute Global Conference earlier this year:

  1. Technology is rapidly decentralizing and transforming markets.
  2. Policymakers and regulators are scrambling to understand the impact of technology, and are simultaneously working to reduce risks posed by increasingly interconnected and automated financial markets.
  3. Market actors are actively and creatively exploring new investment models and opportunities.

The Impact of Technology

Advances in information technology and digital networks are rapidly decentralizing, disintermediating, and in some cases democratizing financial markets. The growth of high-frequency trading facilitated by computer-based algorithms and so-called aEURoedark poolaEUR? platforms that enable investors to buy and sell equities off of traditional exchanges have received significant attention from market participants and policymakers. Proponents of algorithmic high-frequency trading argue that it increases market liquidity and facilitates price discovery. Regulators and skeptics, however, question whether there is yet a full understanding of how these systems affect markets and worry that they may trigger or exacerbate so-called aEURoeflash crashes.aEUR? Proponents of dark pool platforms argue that these provide traditional exchanges with healthy competition that can drive down transaction costs and promote efficient trading. Others counter that dark pools decrease liquidity on primary exchanges and result in market fragmentation.

Technology is also poised to disrupt traditional payment platforms and banking networks as smart and mobile phones are increasingly used to effect financial transactions. Three key barriers, however, must be overcome before these new payment systems largely replace paper currency or credit cards at the point of sale: consumers and businesses must be convinced of the value proposition of the new technology; standardization of delivery models will need to result from the winners of competition between developers; and a sound regulatory framework is needed to reduce consumer privacy concerns while enhancing network security. Whether the transition away from traditional payments takes a year or ten years, eventually digital payment models will become ubiquitous.

The Internet is also changing the way companies and individuals in America are able to access capital. Congress embraced the InternetaEUR(TM)s potential with the Jumpstart Our Businesses Startups (JOBS) Act, which for the first time will legalize securities crowdfunding and allows private securities offerings to be mass marketed to accredited investors. The diverse landscape of securities crowdfunding has potential application (through both debt and equity models) across various industries including real estate, technology, arts and entertainment, consumer products, and local retail and food. New Internet platforms can also help foster efficient capital formation, especially in geographic regions that have long lacked access to capital and in private markets that have historically been constrained by now-repealed regulations restricting the use of modern forms of communication.

Regulators and Policymakers: Trying to Keep Up

Given rapid changes in how technology is affecting markets and the complexity resulting from an increasingly decentralized yet interconnected financial system, regulators around the world face the unenviable task of preventing the next crisis. Bart Chilton, who heads the Commodity Futures Trading Commission, has said that he is not necessarily critical of the proliferation of algorithm-based high-frequency trading, but believes that more research is needed regarding its impact on markets. Others have expressed concern with downward spiraling cascade effects in interconnected financial markets, and stressed the resulting need to coordinate a holistic approach to global financial regulation. Senator Bob Corker has suggested that rather than seeking to regulate specific industries or financial institutions differently, a more practical approach might be to regulate financial activities uniformly regardless of the actors. This approach could solve concerns that stricter regulation of traditional finance institutions will only push certain activities into less regulated shadow banking networks or result in regulatory system arbitrage.

There is also concern that in an effort to aEURoesolveaEUR? the last financial crisis, regulators may in the process stifle economic activity through overregulation or miss new threats to market integrity. Jim Barth, a senior fellow at the Milken Institute, has noted that neither proprietary trading nor the size of banking institutions were the drivers of the financial crisis, yet significant regulatory scrutiny continues to be focused on both of these issues. And in considering additional regulatory reforms in banking and housing finance, some have cautioned that more regulation would likely have a negative impact on credit availability, thus putting downward pressure on economic growth at a time when policymakers are seeking to promote growth. Similar concerns regarding regulatory burden have also been expressed with respect to SEC implementation of the JOBS Act, which requires a delicate balance between ensuring market integrity and not stifling market development.

Investor Opportunities and New Models

With respect to new investment models and opportunities, technology is expected to continue to play a large role, including through high-frequency trading, investment or peer-to-peer lending Internet platforms, electronic exchanges and clearinghouses, and Internet-based private placement networks. Meanwhile, new crowdfunding models will develop in the startup and small-business capital-access space once the SEC finalizes rules implementing the JOBS Act. At the same time, many hedge funds will continue to face competitive pressure as clients consider shifting away from funds and aEURoe2 and 20aEUR? pricing terms in favor of direct investment strategies that utilize low-cost financial products, such as exchange traded funds (ETFs).

All new opportunities, however, come with associated risks. The pace of technological change and the increasingly disintermediated, yet interconnected, nature of markets means that vast sums of money can change hands instantaneously, often at the direction of automated programs. The resulting pressure on regulators to ensure market integrity and confidence will remain significant. Yet, if the right balance between market innovation and sound regulation is struck, then financial markets will be able to continue to drive productive investment and economic growth.