Re-launched in 2011, LMAX Exchange may be a new kid on the FX block but its timing could well be perfect. Global trading volumes have been growing continuously for a decade despite the crisis and so has electronic trading. September 2013 research from Aite Group, entitled Electronic FX Market 2013: Ready for a Revolution, estimated that by the end of 2013, electronic platforms would account for 70% of all trading carried out in the global foreign exchange market. Against this background two other factors are playing a significant role.
Firstly, post-crisis regulation is pushing hard against traditional OTC trading in favour of more transparent market places. While all trading methods, from traditional voice to the latest, low latency technologies, are all still current depending on client preference and currency pair, the trend towards exchange style execution looks inexorable. Second, the competitive landscape is changing dramatically and the once fairly well-defined demarcation between interbank and client-to-dealer markets no longer exists. Traditional interbank venues, such as EBS and Reuters, are facing direct competition from client-to-dealer platforms and increasing dealing banks’ unhappiness with the participation of API-driven automated trading firms on these venues.
Against this background, the arrival of LMAX Exchange looks prescient. Its trading volumes are rocketing month by month, as we shall hear from David Mercer. Moreover its fixed costs and product lead time to market are both low enough to be able to keep competition at bay. The time for LMAX Exchange looks to have come.
David, you have more than 20 years’ experience in the derivatives industry and an extensive expertise in the leveraged FX business. Do you think it’s now harder to be a successful pioneer and achieve lasting change in today’s highly competitive and relatively mature capital markets than it was when you first started out?
I think it’s much easier now and more exciting. There has been a massive evolution in technology, the products traded and the accessibility to a wider audience. I used to have about eight screens on my desk, which cost a fortune to access a pretty simple market. Now you can get that on a web user interface (UI). I can remember sitting in a dealing room where the price of seat was $1m. Now you can access the market for the price of an Internet connection. That’s hugely powerful and very exciting.
People talk about regulatory change but that has always been there and, in any case, we believe in regulated markets. They bring about fairness and greater access for everyone.
I think it’s a fantastic time for everyone. The democratisation, that the Internet has brought, has opened the market up to places like India and all the emerging markets and, of course, everyone else on the street. Previously, they would have had to have called their bank or their broker. So, I think there are huge opportunities now and it’s a very exciting time to be a pioneer.
Why are you such a passionate advocate of the “exchange model” and how would you describe the vision and ambition of LMAX Exchange for changing the way FX trading has traditionally been undertaken?
The real passion is to deliver market access to a wider community. In terms of the exchange model I am very happy if everyone at LMAX Exchange is called an exchange evangelist. That means that we believe in the equality and consistency of execution that you get from an exchange trading model.
I’m not on a crusade to change FX and I’m not critical of the FX industry. It has evolved to where it’s got to. There are now more products traded and volumes have gone up five-fold in the last 15 years, reaching an estimated $5 trillion daily in 2013. So there is space for new players to bring something new, but all clients should expect ease of access and quality and consistency of execution in all financial products. We believe one of those products is spot FX and that this is the best way to trade full stop. We’ll see in the future whether we’re right or not. There is certainly room for us in the FX industry.
LMAX Exchange is well known for being very technology-focused. Why did you choose to make such a large investment in this area and what advantages does the scalability of your technology give you?
We did the heavy technology lifting, so that our partners don’t have to. Whether you’re a bank or a proprietary trading firm you can connect very easily to us. We invested up front in a matching engine that can accommodate up to 100 fold what we currently do in trades.
You have to do that because events can mean that volumes can shoot up to very large levels at any time and it’s no good for a client if, say, the Fed chairman or Mr. Draghi says something and you can’t cope with the volume. You’ve got to build for the peaks. At the same time if you do the investment up front it gives you the opportunity to expand more.
By investing heavily in a matching engine and exchange over the last three to five years we’ve been able to launch two new exchanges in the last six months. If you wanted to set up a new one now from scratch it would probably mean a 12 to 24 month lead-time.
To give you some numbers, at the beginning of 2013 we could process 5,000 orders per second. Now we can process 20,000 orders per second, so we have increased our capacity four fold this year. Our goal over the next six months is to increase this to 100,000 orders per second. There’s a lot of discussion in the FX market about speed and for us it is about message throughput. The more messages we can handle the more it allows our liquidity providers to price accurately at all times and it allows our buy-side clients to more often hit the price they seek.
Part of your technology has been open sourced, what impact is this having on the growth and success of your business?
This is hard to measure. But looking at it holistically, you want to have some fun, make some money and, hopefully, give something back. That’s part of our mind set here and part of the reason for open sourcing.
Now there are three recipients of this, our liquidity providers – banks and non-banks, clients and then there are existing and future employees. So there is a proof to the banks and other liquidity providers that our technology is good. If you want to see that it’s good, just have a look at it. And just to endorse this, there are about ten banks that now use our open technology, so effectively we have given them some software for free.
Likewise some of the more techy clients, who like to build software and develop algorithms themselves, are also using our open source technology. This is because it enables them to process more messages more quickly.
Thirdly, it’s very hard to attract quality technology staff throughout the industry now. And not all of them are totally motivated by money. With technologists it’s more about problem solving and finding elegant solutions. For existing employees it’s great that they can show peers within the industry what they’ve created. I’ve recruited double-digit numbers of people who’ve approached us, because they learnt about us through our open source technology.
You have said in the past that “LMAX Exchange is a transparent and well-policed environment.” What did you mean by that?
Every marketplace needs some rules. And I don’t mean just capital markets. I look at E-Bay or Amazon and like them we have rules in place. We have a published rulebook, logged with the Financial Conduct Authority and available on-line to anyone.
The way I look at markets is like a game of football. It’s fun for everyone, but if there is one guy going round kicking everyone – it’s not fun anymore. It’s no good for the spectators and no good for the participants. So you have this idea of yellow cards and red cards, so that no one can spoil the game.
In the FX market there are certain styles of trading that don’t benefit the marketplace and don’t serve any commercial value to us, as a venue. News traders for example, who only trade on news and probably trade quite rarely. I don’t think there is much value from people who only trade in that style though it must be said that we tend to do the most volume around news events, US non-farm payroll for example. I think that most venues should discourage news traders.
Likewise, there has been an evolution in the marketplace of people who look for arbitrage – technology arbitrage between different platforms. There is not much point in hitting banks on this venue or that venue because you have a minor technology advantage. We discourage that and we feel that there is an obligation in all venues to discourage that.
It’s about KYC. We know our clients and we speak to them. We ask them to fill out a simple questionnaire. And 99.95% of our clients are open and get on and trade. Every once in a while someone comes along and says “this is the way we trade,” and we say “well, this is probably not the best place for you.”
What markets and instruments are now available to trade on LMAX Exchange and what type of traders and investors are increasingly being drawn to its trading services?
Today we offer 62 currency pairs, precious metals including palladium, gold and silver. We offer commodities including spot oil and all of the major indices. We are always looking to add more. We recently added platinum and palladium for example.
In terms of clients we are largely in the institutional space with a B-to-B model rather than B-to-C. Our main client segments are Broker Dealers, who may offer our products to their retail client base in other jurisdictions; followed by Money Managers, who may manage smaller accounts; the third segment is Proprietary Trading Firms.
We have some legacy retail business with a minimum account size of $10,000 for professional traders and high net worth individuals. We expect to gain larger institutions in due course, but stay with our three main segments in the years ahead.
What range of access channels has LMAX Exchange made available to ensure that it offers the widest possible pathways to its services?
We offer access through Web GUI, full suite of mobile apps, FIX and API (.Net, Java). We also cover a range of languages. We want to be platform and market connection agnostic. We are always open to new methods of connection, if that is what clients want.
We operate a market place and we offer a fast, robust, reliable matching engine that we’ve invested time, effort and money in. We grant some of our clients technology that they can use for their clients and we don’t make markets. Ours is a simple model and we need to stay agnostic about how people connect to us.
What steps have you taken over the last year or so to expand the LMAX Exchange user base, and has uptake amongst specific client groups been as you expected?
We are constantly aiming to widen our geographic distribution. We are always looking to get our message and our offering out there and we want people to add us to the venues that they trade on.
So far we offer 13 languages and have clients in 73 countries. We are looking to reach across all segments from funds to professional traders.
Can you tell us a little more about the recently launched LMAX InterBank and LMAX Institutional? What was the rationale for creating these venues?
LMAX InterBank and LMAX Institutional are the two execution venues we’ve launched this year. Once we established the technology they were quite quick to launch. LMAX InterBank was a natural evolution for us. We already had banking partners streaming prices into us, so it made sense to have a bank-only matching engine, even if it is a competitive space. It was relatively cheap to launch and we are gaining traction with 18 of the world’s top 20 banks connected and 12 of them actively trading. We feel positive about the traction and the feedback we’re getting. We’re still small, doing just a few hundred million every day but the volumes are increasing month-by-month. I expect this venue to really come to life in the latter half of 2014.
In what ways does your trading model promote firmer liquidity in the order book and improved execution for participants?
Our order book offers streaming firm limit order liquidity from top tier financial institutions. What you see elsewhere across the industry is what I term an “indicative price,” – “last look” in other words. Our venue has no last look as standard.
Every offer in the book is a firm order that can be accessed by all participants. The price you see is the price you get. You get quality of execution that’s still unique for spot FX, but has existed for a long time in other asset classes.
Do you view increased regulation across the capital markets as a burden that has to be managed or as an opportunity for fast growing, regulated trading venues like LMAX Exchange?
Regulation is a good thing and it gives all market users, whether it’s a professional trader or an asset manager, a reason to have confidence in the prices they receive and in the way transactions are executed. This in turn will promote further liquidity. Regulatory changes, and there are inevitably some that we don’t feel happy about, generally bring improvements. Dodd Frank is obviously an important one for us and we will get on and do whatever it requires of us.
Is there anything else that LMAX Exchange is looking to do to facilitate a more transparent FX marketplace?
While LMAX Exchange does not offer transaction cost analysis (TCA), we offer open market access and we are happy to share our data and place it alongside that from other sources. This enables buy-side clients for example to do their own TCA. They have full transparency so there’s not really much more we can do.
In general it is fair to say that there is likely to be more transparency in the FX market in the future and we are among the leaders in this. Everyone who trades on LMAX Exchange abides by the rules and they are free to check on our transparency.
What plans do you have for increasing the global footprint of LMAX Exchange over the next few years and how big a driver for your business is geography likely to become in the future?
We expect to add matching engine locations in North America and Asia to our existing one in the Equinix data centre in LD4. We have plans to open between one and four sales and distribution offices in 2014.
Ultimately, how will you judge whether you have succeeded at LMAX Exchange and achieved everything you set out to do with the company?
Our key performance indicators are linked to the interests of our stakeholders. Obviously we want to gain more customers and increase the flow through our venues and we believe this will happen if we have happy liquidity providers, clients, shareholders and staff.
Of course, we are playing to win and we want to be the leading FX venue within three years. Our volumes have grown at over 60% quarterly compounded for the last nine quarters (or since the re-launch of LMAX Exchange in Q3’11). Based on our calculations of the addressable spot FX market, our recent volumes give us 1-2% market share.
But the key thing is that we aim to make more dollars per million traded than our competitors. While our competitors are making roughly $3/million traded we make $15/million. Ours may fall in due course but because we have lower marginal costs to scale we have ample room to be profitable, as our volumes increase. Suffice to say, we are very excited about the future and that LMAX Exchange is leading the move to exchange trading which regulation is bringing about.
There is no doubt that the LMAX Exchange star is rising, but its market share is still small. The history of markets and technologies is littered with ventures that failed to fulfil their potential and with consolidations among players that could not establish themselves as the standard.
However, the LMAX Exchange offering appears to meet many of the requirements of the FX market at this point in history. And each new crisis and alleged malpractice in financial markets does tend to wrest influence from traditional methods of transacting, in favour of tighter governance and greater transparency.
FX is the most liquid market and, in the major currency pairs, among the most competitive that there is. The LMAX Exchange looks to have made remarkable inroads already and, led by David Mercer, it is certainly aiming high and growing fast. The next two years will show us whether LMAX Exchange can become the transaction venue of choice; its timing could hardly have been more fortuitous.