Building the benchmark for global FX

e-Forex talks with David Mercer, CEO of LMAX Exchange

First Published: e-Forex Magazine 63 / e-Forex Interview / January, 2016

Building the benchmark for global FX

David, it’s two years since you last did a major interview with e-Forex. You said at the time that LMAX Exchange was playing to win and had some very ambitious growth targets. Has everything been going according to plan since then?

We’ve had a busy two years. After being ranked the number one fastest growing technology firm in the UK in 2014, we established a significant presence in Asia-Pacific: a fully regulated broker in Hong Kong, office in Singapore, focused on institutional relationships and a matching engine in Tokyo. In 2015 we’ve also launched our prime-of-prime service and I’m happy to say that we’re making significant headway in the institutional space with 30% growth in give-up volumes. That said, you can’t get away from 2015 having been a difficult year for everyone in FX after the market dislocation, caused by the SNB removing their currency peg. But with that in mind, I’d say that our business has held up well. In 2015 we are probably one of the few venues to show volume growth.

Over $4 trillion has now been traded on LMAX Exchange to date which is a pretty impressive figure. What range of instruments are we talking about?

Actually, we’re rapidly closing in on $5 trillion, so that’s a good number. We’re still predominantly spot foreign exchange, with over 80 currency pairs offered. But our metals and indices business is growing nicely, currently accounting for around 10% of our monthly volumes. Our target is to grow that to around 20% over 2016. The growth will be driven predominantly by European indices, led by the DAX, and metals, led by gold. Both metals and indices products are close to industry-leading in terms of spread and depth. You’ve got to sell your customer what they demand. There’s a lot of demand in Asia for metals and commodities in general. Certainly we see a lot of demand for gold in particular from Asia-Pacific. That’s been a lot of our growth and we have big hopes for that in 2016, but our core product remains foreign exchange.

Building the benchmark for global FX

You operate a B-to-B model rather than B-to-C and traditionally have been mainly servicing broker-dealers, money managers and boutique fund managers. Does LMAX Exchange intend to attract larger institutions and perhaps broaden the existing target client segments in the future?

I think we need to do better in the institutional segment and potentially go after corporates and real money. We have a lot of interest from funds in North America, so that’s a good growth area for us in 2016 and 2017. Corporates and real money is a bit more difficult to target or to attract – they’re pretty set in their ways. But I think longer term we will operate in that space. Certainly moving up the value chain in the institutional segment is an ongoing focus for us.

Let’s talk about ‘last look’ in FX. After the FEMR report was published, your position was clear that this practice was no longer required given the advances in trading technology. Are you confident of winning that argument and what steps would you encourage regulators to take in terms of engaging with the industry that might strengthen your case?

It’s a tricky one. The short answer to your question - I’m not confident at all that we’ll win the argument. There seems to be an awful lot of resistance from the wider marketplace and people protecting their own position. Our stance is pretty simple and two-fold. The second bit is probably less well publicised. The first bit is clear: ‘last look’ is a practice open to abuse and it should be abolished on anonymous multi-dealer platforms, where the customer is unsure of the liquidity they’re accessing. We’re pretty clear on that, it shouldn’t exist on any multi-dealer venue, any ECN, any MTF or any exchange. 

It doesn’t occur in other asset classes, and we don’t think it belongs in FX. To press that point, 85% of respondents in our last survey said ‘last look’ was a practice open to abuse. It’s pretty evident to me, in the wake of the fines and investigations that we’ve seen over the last year or two, we can remove this one-way optionality and it would be a big step in helping to restore trust and faith in the FX market. 

The second bit: there are bilateral relationships in FX and they can be exactly what they say they are. If a bank or a non-bank agree certain execution tolerances with their customers on a bilateral basis, which may or may not include ‘last look’, that should be permissible in an OTC marketplace. In short, we don’t believe in ‘last look’ on anonymous venues, whether they are exchanges, MTFs or ECNs. But it may exist in bilateral relationships, between a bank or a non-bank and their customer. 

My fear is that everyone’s putting ‘last look’ in one basket. The various working groups, I think, are taking a complete wrong turn by trying to standardise something which is by definition entirely non-standard, depending on who your customer and who your liquidity provider is. I’m not confident that we’ll win the argument in the short term.  I am confident that the market will exist without ‘last look’ in a longer time horizon, be that five or 10 years. Our view is that ‘last look’ should be ended now and that would be a big step in restoring trust in the market.

“We invest nearly 60% of all our costs every year in technology”
“We invest nearly 60% of all our costs every year in technology”

You have been saying that what LMAX Exchange has created is not just a company that is profitable and rapidly growing, but a blueprint for global transparency that is driving long term disruption in the largest asset class in the world. What did you mean by that?

There are some fundamental pillars to that. We have a public rulebook; everyone has the same rules applied to them. There is open access to the marketplace. There is truly a level playing field for all our market participants, regardless of status, size or activity levels. It’s purely firm liquidity, i.e. no ‘last look’ liquidity; this ensures certainty and consistency of execution. And market data - expensive in this day and age and relatively hard to access for everyone - on LMAX Exchange is firm, fast and it’s free. But probably most important, in terms of the disruption, is that we do this within an existing marketplace with a lot of legacy plumbing but we do it with the support of all the major players. 

Twenty-five of the world’s top tier banks and nine of the world’s largest non-banks are providing liquidity and are effectively partnering with LMAX Exchange; this demonstrates that this new way of trading in an OTC marketplace can be efficient for all market participants. The FX market does not need to be opaque.

Part of the disruption is the investment in technology. We invest nearly 60% of all our costs every year in technology. We develop our software in house and with those pillars that we set down we create challenges for ourselves. And we overcome those challenges by harnessing world-leading technology. 

We build our own market surveillance tool, our own credit monitoring tool; we focus a lot on allowing liquidity providers to price precisely. They can cancel and update an order in 80 microseconds to protect themselves from dealing on stale prices. All of those things together can help to disrupt capital markets and basically move us away from the status quo of the last 20 years.

We spent much of 2015 talking about the SNB debacle. What long term impact do you think this extraordinary event will have on the wider FX market and what might that mean for LMAX Exchange?

Overall, I think it was a bad thing. There was short-term volatility, which produced higher volumes but at a price. I wouldn’t even call it volatility, I’d call it a market dislocation, the like of which we haven’t seen. I was in the markets when the UK removed sterling from the ERM in 1992. The SNB event surpassed that in terms of shock. Certainly it surpassed the shocks we saw in the Asian crisis in 1997, the Russian rouble crisis in 1998 and even the one most recently, the credit crunch in 2008. 

It was a short-term massive gap in the market place for about 15 minutes that will have reverberations for perhaps the next 15 months. A lot of people left the market, or were forced out of the market, due to the losses they made. And I think overall there’s been a tightening of credit, which affected people’s ability to trade and had a knock-on effect throughout the marketplace. Likewise on liquidity: liquidity providers were perhaps a bit more reticent to provide the same levels of liquidity after that event. I certainly think 2015 has been characterised by people being wary of the market.

One thing the SNB event really highlighted - when is liquidity real liquidity? The answer is when it’s firm liquidity like on LMAX Exchange.  We saw a lot of ‘liquidity’ disappear on January 15th. That’s because a lot of the ‘liquidity’ is just re-vended indicative quotes. I think that’s something which will come to the fore in the times ahead.

Building the benchmark for global FX

Last year you launched LMAX Prime, a prime-of-prime (PoP) service. In what ways have you set out to differentiate this offering from others and why is demand for it so strong?

I’d say our real differentiator is the investment in technology. We’ve built our own pre-trade risk model so we can use that for every non-margin customer. 

We credit check every customer before they trade with any of the LPs or any of the venues in the offering. That gives us – and it gives the market – comfort. We’re not introducing any additional risk for us, or for a prime-of-prime provider, than we would have with a regular margin customer. 

Harnessing that technology, again we’ve been able to give the customer a choice of single bank liquidity, other ECN liquidity or our own LMAX Exchange liquidity, and probably most importantly, a mix of all three, which is unique. It’s that flexibility, added to our technology, which is increasing demand for the offering. We will do better, we can do better. 

We’re probably averaging only around half a billion a day in prime-of-prime, but that’s from a starting point of zero nine months ago. It’s going well and I expect the volumes to be a multiple of the current ones in 12 months’ time.

With a growing international client base operating in 90 countries, LMAX Exchange now has an extensive global reach. What steps have you recently been taking to further expand client access to your liquidity around the world?

In terms of our presence in Asia-Pacific, that’s been a big part of our growth strategy in the last 12-18 months. We have a fully regulated broker in Hong Kong, a matching engine in Tokyo, a small office in Singapore and even a SWAT technology team down in New Zealand. Our offering, sales & marketing, websites are in all the local languages. That’s been the big push, as well as adding products that are interesting for that marketplace, such as CNH. Growth in Asia is work in progress, but the region already represents over a third of all our daily volume and we see that just growing from here.

North America is an area we need to look at. We’ve seeded our growth strategy in North America during 2015 and now have a team of two in Chicago. In 2016 we’re looking to expand further in Chicago and New York. We have a lot of interest from larger fund-type clients in that region. A lot of our liquidity providers are based in New York and Chicago, so it’s important that we move towards them and then also attract buy-side customers. That’s very much a work in progress. We led our global expansion in Asia, we’re going to follow that in North America. 

Building the benchmark for global FX

For the last three years LMAX Exchange has been ranked as one of the UK’s fastest growing technology companies by Sunday Times Tech Track 100 league table, so IT is clearly a core competency of the company. What prompted you to become a member of the Linux Foundation and what do you like about the power of open source technology, especially in the financial services?

Linux is the key operating system for all low-latency exchanges. It’s a critical component of building a reliable low latency exchange. So membership gives us a voice in a foundation that includes all the key players, including Linus Torvalds himself. We’ve been involved in various initiatives this year; most recently we contributed to the core infrastructure initiative - a Linux Foundation project which invests in the core parts of the infrastructure, all the unsexy stuff which is key to everyone in this space. It’s vital that we have a voice and that we contribute to that by supporting the Linux Foundation. That membership gives us access to people who develop right at the core of Linux, and we’re able to benefit from that, and, as we did this year, recommend changes and have them implemented. 

More generally, we believe in open source for a couple of reasons. One, we like to innovate and give back to the marketplace that we learn from. We use a lot of open source technology ourselves, so it’s good to put something back. And two, on a people front, it’s a good way for us to attract and keep talent. Technologists these days like to be involved in the projects that go outside of their niche area, financial technology, and where they can contribute outside of their normal realm. I think it is pretty key and it has served as a good tool for marketing our products, our expertise and for attracting new talent to LMAX Exchange.

“At LMAX Exchange, we strongly believe we can create extraordinary results in what is a huge marketplace.”
“At LMAX Exchange, we strongly believe we can create extraordinary results in what is a huge marketplace.”

We are intrigued that some of the world’s largest banks have joined a partnership to develop financial market applications based around distributed ledger technologies, whilst at least one firm is looking to leverage the same technology to build an innovative FX matching engine and platform. How are you positioning LMAX Exchange to capture the opportunities presented by cryptocurrencies and the technologies that power them such as the Blockchain?

It’s a very interesting space. We’ve had many conversations this year and I have conversations most weeks about cryptocurrencies and distributed ledger technology. It may be a little too early for me to say anything but I’d definitely say watch this space. I’m currently looking at a significant potential partnership. Irrespective of how that plays out, I think we’ll be very much involved in distributed ledger technology in the coming years. 

From a personal standpoint, I believe there’s a revolution in capital markets coming:  the Blockchain distributed ledger technology or derivatives thereof will lead the way. We want to be part of that revolution, and we’ve certainly got our irons in the fire and we’re keeping abreast of it, so that when the revolution comes we can play a big part. I think the most obvious place for it to be used is in settlement, payments and all the reconciliation that it entails. 

That plumbing is quite dated within all capital markets and certainly within FX. I think there’s a big change coming and that’s where the revolution will start. Everyone’s looking at the products traded, whether it be Ripple or Bitcoin, but it’s really harnessing the technology behind all of that. The change will start in the back office and it will start with settlement and everything entailed there. That’s the revolution I see happening in the next 10 years and certainly we want to be a part of it.

LMAX Exchange is sponsoring a team in the biennial Clipper Round the World Yacht Race, which, incidentally, was the first to reach Rio de Janeiro and win the opening leg. In what ways are very tough and demanding events like this symbolic for you and in what ways do they provide a source of motivation for the firm?

The world’s oceans are vast and pretty unforgiving, as is the capital markets space when you come into it. It’s a pretty tough environment. But we believe that with modern technology no company is too small to succeed. The Clipper race is all about ordinary people doing extraordinary things. At LMAX Exchange, we strongly believe we can create extraordinary results in what is a huge marketplace. The Clipper race is very much aligned with our ethos: we see that all these guys – whether they be firemen, dentists, doctors, lawyers, PR people – are on the boat and they’re circumnavigating around the world in 11 months, something which they couldn’t have seen from their desks 12 months ago. If they can do it, then we can do it.

A final question. You have put a great deal of effort into making the LMAX Exchange business model work and have achieved very significant traction in FX. What’s your ultimate goal for the business?

We’ve only just started. For me, we’ve proved the concept that exchange style trading and level playing field trading environment can work in FX. 

We’ve proved the concept and we now need to kick on. We are building the benchmark for global FX.

Of course we aim to win. By aiming to win, we want to be number one in the marketplace. It’s a big market and I know it’s tough to do. But that has to be our goal. We have to be in it to win it.

Building the benchmark for global FX