David, when we last interviewed you two years ago LMAX Exchange had just sponsored a team in the biennial Clipper Round the World Yacht Race. You then joined for race six of the 14-stage series, with Team LMAX Exchange going on to be crowned the overall winners. How inspiring was this experience for the company and you personally?
It was a fantastic experience for the brand overall – both for all our employees as well as our clients and partners. It was quite a feat. I particularly valued the team ethic which came from being part of a 23-man crew. What I discovered very quickly was that if one of you didn’t perform, then you were in for a bumpy ride. So it was in fact very similar to running a company. At LMAX Exchange we’re quite eclectic and when we started talking to the market about our approach back in 2011 no one had heard of us, or were willing to give us a chance. Yet here we are, seven years on - now we’re halfway through the race and I think we’re well positioned as we approached the finish line.
And of course 2016 was a notably good year for LMAX Exchange, as you were able to build on your technology investments in 2015 while also continuing your strong growth trajectory. How has 2017 turned out?
All things being well, I expect it will be our best year to date. Certainly Q3 2017 was our best quarter ever across every metric - and within that we also had a record month.
It’s very exciting and the flow of our business is more diverse than ever, but we also strive to lead the market and we are a long way from that just now. So we can’t be complacent and need to extend and expand every year. I think we’ve done that.
I’m naturally ambitious - and I suppose a hard taskmaster - so it’s never quite enough, yet all I can ask is that every year is better than the last.
You also set out to prove that the exchange execution model based on central limit order book (CLOB) with streaming firm limit order liquidity, supported by best of breed technology and unparalleled market data, is the only way to trade the world’s largest asset class. Has that proved more difficult that you anticipated and how successful do you think you have been so far?
We have a proven concept that this is an efficient, fair, transparent way to trade FX at a lower trading cost. Our partners prove that point, over 100 brokers in the world prove that point, over 23 banks connected prove that point, over 10 of the world’s largest proprietary trading firms prove that point. So everything proves that it can work. But has it been more difficult than we thought? The answer is yes.
We haven’t won yet. We haven’t convinced 100% of the market that ours is a better way to trade. But I think we’re getting there. It’s always good when you set up to transform an industry - or to bring something new to have a certain amount of naivety. We certainly had this back in 2011. A naivety that comes with the belief that you can change it all with just the flick of a switch. But the reality is that in an established, complex, global OTC FX market, a new player with a simple idea wasn’t going to change it overnight. And yet it is changing, albeit gradually. I hope we’ve added to the market structure debates and that we’ve added to greater transparency that you see in initiatives like the FX Global Code of Conduct, rather than just being an irritant to the establishment.
So we’ve certainly had something to do with the erosion of ‘last look’ hold times, the greater move towards transparency and improving market access for clients. I think we have also helped sell the benefits of CLOBs and firm liquidity, which has in turn helped the FX market move to a better place. But as we mature, we’re aware that perhaps we have to be more pragmatic in our approach.
How has the make-up and global presence of your client base changed and grown over the last year?
We are trying to cover the globe in terms of client base so we now have a matching engine in London, a matching engine in New York and a matching engine in Tokyo. We also have a regulated broker in London and Hong Kong, an operating presence in New York, Chicago, Singapore, Hong Kong and London, in addition to development offices based in Auckland and Brisbane.
So we’ve got the world covered. In terms of liquidity provision, we now also have most of the world’s leading banks, proprietary trading firms and non-bank liquidity providers connected. And for buy-side flow, we’ve done very well in the broker space - and to a certain extent in the introducing broker segment as well – as well as having a strong footprint in terms of proprietary trading firms and small funds. Those two segments comprise around 80 percent of our flow.
Where we need to do better going forward is in the real money and asset management space. And then on the product itself, we have a long way to go in terms of adding the full remit of FX product to include swaps and options as well.
Earlier this year LMAX Exchange published a white paper offering a new blueprint for FX TCA that leads to more consistent calculation of FX trading costs across different types of liquidity. Why do you think the current system for assessing the true cost of trading is broken and what can be done about it?
This is a very important step for LMAX Exchange. We put a lot of time and effort into this research paper in order to help educate the market and help pinpoint what we think the key metrics, or standardised metrics, should be across the industry. And if the buy side can measure these five key metrics, then they will be able to answer all seven execution factors which MiFID II mandates them to produce.
But do I think the current system is broken? It’s broken in that it’s far too complicated for a client to assess their cost of trading and to demonstrate best execution. FX is a diverse, OTC market and some asset managers are just not sure where they are supposed to get their market data from or how they are supposed to calculate “best execution”.
It is a big scary term and a big scary question, so we broke it down into bite size chunks and arrived at five key questions, or metrics. And you can tell that we did this for the benefit of the industry because we didn’t even win in all five metrics, but we believe that across all metrics we are the best overall.
We believe that we can convince the market place that fairest execution, lowest cost of trading and certainly the greatest transparency of trading will be on a CLOB with firm liquidity. But it’s really a case of caveat emptor – buyer beware. We break it all down for them and show that it is just basic arithmetic if they have the right market data, and if they don’t - their liquidity provider, venue, bank or non-bank market maker should be able to provide it for them. Then they can truly compare different styles of execution and arrive at the right answer for their style of trading.
LMAX Exchange has always been a strong advocate of FX market reform and you became the first organisation to publicly commit to the FX Global Code of Conduct. How does the Code, as well as broader regulatory change in the markets, impact your business model and value proposition?
I believe the regulators, as well as the rest of the industry, will have to move more towards our model. It’s as simple as that. We complied to the Principles of the Global Code for seven years before it was even launched and we also go a step further in terms of the contentious wording of Principles 11 and 17 of the Code. Principle 17 has recently been altered - but trading in the last look window simply isn’t available on LMAX Exchange, because we don’t have a last look window.
And it is a similar picture in terms of where we stand on regulatory change. MiFID II’s underlying message is about fairness and transparency, which also plays into our business model because trading on a CLOB and trading on firm liquidity ticks both boxes. I think regulations and the Code of Conduct are moving in our direction. It doesn’t alter what we do. That’s why it is so easy for us to sign a commitment to the Global Code.
The real challenge here is for the industry to grasp the metal and show that it can really change. I fully support efforts like the Global Code if that’s what we get to, but the industry must show it collectively. We can help ourselves by enforcing change now.
How strategically important is the Asia Pacific region to LMAX Exchange and your global growth agenda?
Asia-Pacific has always punched well above its weight for LMAX Exchange and the region was an early adopter of our business model. To be honest, back in 2012/2013 that came as something of a surprise. So we kept on investing heavily in that region. We put a matching engine in TY3 three years ago, we established a regulated broker in Hong Kong two years ago and we established a regional hub in Singapore just recently. I even moved one of my key resources, former COO Scott Moffat, to be the Managing Director for the region.
It’s a key area, both for LMAX Exchange and the wider FX industry. Today it represents around 30 percent of our revenues, slightly less in terms of trading volumes. Globally, I think it is going to be very important for the capital markets industry going forward and for us especially in the next five years.
A lot of your liquidity providers are based in New York and Chicago - and you have also continued to expand in the US institutional and interbank client segments since the launch of your North American matching engine in New York (NY4) in 2016. How much potential growth do you see for LMAX Exchange in the US?
In many ways, it is a much more mature FX market than Asia-Pacific - but we were rather late to the party. That was a decision we made three or four years ago. It is a very important region for the FX industry, accounting for approximately 20% of the global FX market, yet when we were a smaller company we simply couldn’t spread ourselves too thin. We had to choose between Asia or the Americas. But now we cover the globe.
The challenge is that the US is a very mature market and it is already very well covered by all the major competitors. But I’m confident that the results we’ve had in other areas of the world will also help us accelerate our growth in the Americas. We were able to establish a matching engine in NY4 over a year ago. I’m very pleased with the progress and we’re adding staff all the time. Just in the last quarter, we onboarded some 20 new significant clients. The hard part is to persuade them to move their trading volumes from other venues and liquidity providers to LMAX Exchange.
What efforts have your IT team been making over the last year or so to build upon your proprietary, ultra-low latency technology?
It’s a constant focus for us. At least half of my budget is spent on technology - and the other half was developed by technology. We rewrite about one third of our code base every year. A lot of that is simply learning new ways to become more robust, to become more scalable and to be able to process more messages in a shorter period of time. So performance and capacity are always number one on our list.
The biggest thing that feeds that engine is the people. I never turn off the recruitment tap and am always on the lookout for the best new brains in the area of low latency technology. We also spent a lot of time over the past 12 months developing our trade analysis tools, which we talk about in our FX TCA white paper. I can now demonstrate to our clients the impact of all five TCA metrics on their total cost of trading; these metrics are fill ratio, price variation (price improvement or price slippage), hold time, bid-offer spread and market impact. So now we have some of the best analytics tools in the market freely available to all of our clients, all the time.
But there has been an additional overhead in the capital markets industry over the past twelve months, which was caused by MiFID II. A lot of our time in the last six months has been spent dotting the i’s and crossing the t’s, making sure that we’re ready for the January 2018 implementation. But I’m happy to say that we are well on track.
What about your product offering? Have you expanded this in any way recently, for example with respect to pricing, or launched any new features and functionality for clients?
Probably the biggest thing we’ve done is added depth of liquidity to all our exchanges - LD4, TY3 and NY4. We’ve also added the odd currency pair and improved our world leading gold product. But perhaps the most significant change has been in improving our offering for retail brokers.
We now potentially have the best offering in terms of connectivity, liquidity and cost of trading for retail brokers in the world. It’s a bespoke offering for that important section of the market. It services the end user of any size, from the smallest to the biggest, and services the whole industry because liquidity providers and market makers crave that flow. It’s been one of the most pleasing parts of the business this year and has already seen some 40% growth in 2017 alone. We’ve done very well and are looking to further enhance our offering and better service that segment of the market.
You have told us before that you believe there’s a revolution in the capital markets coming, and the Blockchain distributed ledger technology will lead the way. e-Forex is increasingly focusing on developments in this space and also looking at the technology and platforms required to trade cryptocurrencies and access crypto liquidity. In what ways is LMAX Exchange looking at getting involved in these exciting – yet in some cases potentially risky - areas?
We are big believers in the long-term use of blockchain technology, so we are engaging with a number of partners on its use in settlement and clearing. It’s very exciting for the whole capital markets industry, but for it to change the market there has to be widespread adoption by the majority of the market.
But foremost in our minds in the last two years has been the risk around cryptocurrencies and it has probably prevented us from entering the market in any significant way. I don’t think we’ll stay out of market forever, but we might need cryptocurrencies and crypto-assets to become slightly more mature before we make a larger entrance in the market. We need to focus on our core offering in fiat currencies first.
What steps have you taken to protect LMAX Exchange against any downsides arising from Brexit and the ongoing uncertainty about the preservation of access to the single European market?
We have researched regulation in other European jurisdictions, we have researched the cost of moving and what exactly would have to be moved if there is a hard Brexit. We’re very fortunate that over two-thirds of our business is conducted outside of the EU zone – and in many ways the FX market protects companies like ours from a hard Brexit. Like many smaller entities, we can afford to sit back and wait until 2018 before we have to make a decision.
If we had to move our business, we could do that within three to six months. But I’m still of the opinion that it won’t be necessary as they will most likely realise that we work better with common ground, if not a common market, and that there are benefits to having a strong trade agreement - which hopefully will include the capital markets space as well.
Finally, what’s at the top of your “to do” list for 2018 and how will you be looking to further diversify and grow your client base?
Get even bigger and better. We know where we are, we know what we’re good at - and we know what we’re not so good at. We have to build on our strengths, which are our certainty of purpose and expert technology. But we need to be able to talk to more clients, in more segments, in more geographic locations, and more frequently.
We also need to expand our foreign exchange product, which means moving into products outside spot FX in 2018/19. NDFs will be launched at the start of next year and we’ll start looking at the FX Forwards and Swaps market as well, and potentially even FX Options further down the line.
Ultimately, we need to grow our revenues and our client base, as well as becoming more relevant in the institutional space. We have to prove that the exchange execution model is the best, most transparent and efficient way to trade FX – both now and for the future.
Link to white paper: https://www.lmax.com/FX-TCA-Transaction-Cost-Analysis-white-paper.pdf