LMAX Exchange Looks Ahead after Management Buyout
Profit & Loss, February 2013 – David Mercer, CEO of the firm, wants LMAX Exchange to be seen differently. He is keen to stress that it is not an ECN – it is a regulated multilateral trading facility (MTF) that supports the trading of spot foreign exchange – and that its technology provides it with a real differentiator when potential clients are selecting their trading venue.
The last five years have seen LMAX travel a somewhat rocky road, with a genesis in 2007 from the Betfair – retail client-toretail client – model, which struggled from the start, through a relaunch in mid-late 2011, to a management buyout in late 2012 as Betfair’s board decided it wanted to rationalise its business. In 2010, Goldman Sachs took a minority stake in the company, but as it struggled to build liquidity and volumes, senior members of the management team, including CEO Robin Osmond, left the company. Goldman sold its investment in LMAX Exchange in late 2011.
Mercer joined the firm in April 2011 with the task of analysing what was going wrong and in September/October 2011, what he calls “the real re-launch” occurred.
Since then times have been good, it seems. “We studied the business and it was apparent that the client base needed tweaking,” he explains. “We tweaked the client segments we were going after, from the true end-user retail client, to the retail brokers that serviced them.
“Volumes since have been growing healthily – and I know we are coming from almost a zero base, but they are still heartening,” he adds.
Six months after the re-launch, Mercer says average daily volumes were in the one-to-two billion per day range, at the tail end of 2012 they were closer to five billion per day on a single count basis. By any standards, that growth sits well alongside an industry that appears to be seeing declining volumes, or at very best (with one or two exceptions) flat volume profiles. It is against this background that LMAX Exchange was sold to members of its management team by Betfair for £2.4 million. The deal, which was ratified by the UK’s Financial Services Authority (FSA) in mid-January, results in Betfair retaining a 33% stake in the company. The sale is part of a strategy by Betfair to cut costs, sell off non-gambling assets and focus on ‘core business investments’ under new chief executive, Breon Corcoran. The transaction has been under discussion for several months, LMAX officials say.
The 67% management buyout has been led by Mercer and is backed by private investors including Betfair co-founder Ed Wray. Mercer says the transaction is a positive milestone for LMAX, which is 16 months into a fully funded three-year business plan.
“LMAX Exchange has clearly benefited from being part of the Betfair group. However, our new status as an employee-owned company gives the business the required flexibility to rapidly grow and evolve,” he says.
“This is an exciting time for everybody involved with LMAX Exchange, including staff, clients and partners. From the perspective of our customers and MTF members, it’s business as usual,” Mercer continues. “We have demonstrated traction and an ability to perform to the business plan over the last 16 months and we look forward to continuing that momentum.”
The decision to sell has puzzled some market observers who see FX trading as one of the few growth areas in the Betfair business. Certainly Wray is upbeat, noting, “The LMAX Exchange business has great momentum. As a result, and as a long standing passionate advocate of the exchange model, I am very excited to be part of the team buying the business and look forward to it going from strength to strength in the next couple of years.” Mercer says the platform has retained a strong balance sheet, and in compliance with FSA regulations, continues to hold a healthy capital adequacy surplus with all private client funds held in segregated accounts. Noting that the business is half-way through a fully funded business plan, he suggests that future funding will be required for a very different objective. “The next stage for us is growth capital, rather than funding,” he says. “We are London-based but I want to build out geographically and in product terms. As a regulated MTF the US market would seem to offer good potential and we are already seeing a lot of traction from customers in Asia Pacific and Eastern Europe. At some stage it would probably make sense to have businesses on the ground in those areas.”
Being Different
Whilst he believes there is room for more entrants in the multidealer platform industry, Mercer is adamant they “cannot just be a different flavour of ECN”. Indeed he remains a passionate advocate of the exchange model, where, as he terms it, “the price you see is the price you get”. This means no ‘last look’, a feature still enabled on some ECNs, but not all. “I think last look will disappear from the market at some stage,” he says. “Rejection rates are becoming a bigger and bigger issue for customers, and that makes last look unattractive as a model.
“The market seems obsessed with quote/fill ratios and the like, but that isn’t an issue for us as we have 100% fill ratios on market orders,” he continues. “We currently don’t operate at a level where we would be seen as competition for ECNs, but I believe we could be as the popularity of last look wanes and that of exchange-style trading grows.”
Mercer accepts that last look is popular among liquidity providers, but believes that the mix of customer demand for no last look, allied to LMAX’s speed, can dampen opposition to the model. “The speed at which general members [LMAX Exchange’s name for liquidity providers] can operate on the platform more than compensates for no last look,” he argues. “Participants can cancel and replace in 1.5 milliseconds on the platform – and that is round trip time – which means they can be more comfortable that they are not going to be gamed.”
Talk of speed inevitably raises the subject of high frequency traders and “gaming”, where (typically HFT) players exploit latency on a platform. “When technology was less uniform, especially across the banking and prop shop worlds, gaming was everywhere and it was damaging,” he says. “I think the banks especially have caught up and price much smarter so it is less of an issue – and by giving such a quick round trip, we are using technology to level the playing field. At 1.5 milliseconds, it’s very hard to game the platform.”
The test of its ability to cope with HFT and other segments will come – Mercer admits that currently there are no customers on the platform that would meet the HFT description – but he remains confident that the technology will withstand the test. He also believes it offers something different. “The LMAX Exchange Disruptor technology cuts down queues and has enabled us to trim round trip times – we have worked out a smart way of doing this and our general members seem to like it,” he says.
Part of the technology proposition is based upon Open Source, which promotes transparency and the sharing of technology expertise, and is supported as a concept by, among other institutions, Deutsche Bank. “We are a registered MTF so we have to be transparent about our rules and technology, and Open Source is a part of that,” explains Mercer. “This transparency and the knowledge that we are operating at the top end of the pyramid helps us win people to our proposition, be they customers or tech staff.
‘Techies’ are the new rock stars of the business world, just as dealers were years ago. There is huge demand for their services so to employ the best you have to demonstrate you can satisfy their demands.
“I think you need to share ideas with each other to improve them and that is what Open Source is about,” he adds. “This is helping us attract some great technical staff and provides assurance to our customers that we are on top of the technical challenge. It makes us unique.”
Target Audience
LMAX Exchange could also have the advantage of being ahead of the game in terms of its core relationships. At a time when more and more people are moving, or planning a move, out of the retail FX space into the technology for retail broker space, LMAX has been there for 18 months, having started as a retail-orientated platform, but switching tracks 18 months ago to target the retail brokers.
“The retail brokers are our core customer base,” Mercer acknowledges. “They have excellent distribution networks and are well embedded with the end customer base. It makes no sense for us to compete with them, it’s expensive and unnecessary. Instead, we offer the brokers a venue on which they can execute their aggregated business.”
Although he stresses that LMAX “continues to add clients” in the retail brokerage space, Mercer is also keen to push into new customer segments. “I think we have a very attractive model for money managers, especially outside Europe, where the number of private account, family money managers are growing strongly,” he says. “I think that will be our next target and from there we can push into the professional traders space, to smaller hedge funds. There is a lot of crossover between retail and institutional, we currently sit there so it makes sense to expand customer segments.”
By sitting between the retail brokers and the ECNs, LMAX, as a provider of an exchange-type venue to retail brokers and aggregators, appears to be first into a niche; however, competition is coming, especially from retail brokers moving out of the US to avoid the stringent local regulations surrounding retail FX brokerage.
For once, though, one can hear the line “we welcome competition” and understand it. As Mercer notes, “Competition is good for us because it validates what we are doing and raises its profile. Sometimes a good idea gains traction through imitation and competition.”
A paradox of its model is that while it is an exchange-style trading venue which matches orders, the nine general members, or liquidity providers (Mercer says three more are in the process of signing up), cannot hit each others’ prices although they can see them. “If you want to offer great pricing and deep liquidity you have to have happy liquidity providers which means you have to offer them the right environment to operate in,” Mercer says. “If our customers wanted a venue on which liquidity providers would deal with each other, we are happy to provide it, but at the moment the demand isn’t there.
“Our general members are happy with how things are going, they are doing more business on LMAX Exchange, which validates our model.”
Looking Forward…and Back
It could be the impact of regulation, it could be a more realistic attitude from the banking industry, or indeed it could be that the banks have caught up in technology terms, but either way, there is no escaping the notion that the LMAX Exchange model is building momentum where others could not.
The idea of an OTC exchange mechanism is not new of course, for around the time the initial LMAX model was launched, FXMarketSpace, the joint venture between CME Group and Reuters went live, and was shut down after only 18 months of business through a failure to build volumes or validate the model. Although he has no opinion on FXMS, Mercer does think the time is ripe for an OTC exchange model. “I think a blend of the new regulations, which have raised the profile of exchange trading, the advance of technology and the fact we have a specific business model have made our model more acceptable than it could have been in the past,” he suggests. “Five years ago the FX industry was happy with what it had, the technology wasn’t there to advance the model, so if we had gone to people and said ‘we are going to set up a regulated, exchange-style, venue’ they would have smiled politely and declined.
“The big difference for us, is that our model works for our targeted segment, it makes it much easier to capture that flow, and that is of value to liquidity providers especially.” Looking ahead, Mercer believes that “if” the regulations are pushed towards spot FX, LMAX Exchange is “well placed to benefit from that”; however, he strongly opposes such a move. “I think it would be silly to clear spot FX. We are proponents of exchange-style trading, not centrally cleared markets, at least not spot FX,” he says. “The prime brokerage model works well and I don’t see any reason why the regulators should mess with it.” In terms of the keys to success, he stresses scalability and stability. “We have not had a second of downtime in market hours for a year – and that includes the period spent switching from GS2 to LD4 to be with the majority of FX players,” he says. “Our technology also gives us tremendous scale and our business model is simple. We run a simple OTC exchange executing spot FX, where the price you see is the price you get. We run matching technology very well and that model works best in deep, liquid markets.
“Going forward, we would like to grow geographically, currently 60% of our business comes from clients in Eastern Europe and Asia Pacific so it would be good to be on the ground there,” he adds. “We would also like to explore other instruments like forwards, swaps and options, but that will be further down the road – sales and distribution growth comes first as that will help us build our business further and give us the footprint we desire.”
As to where he wants the business to be in years to come, Mercer is firm. “I want LMAX Exchange to be seen as the premier FX venue, operating across different client segments,” he says. “I want us to be fully relevant and fully engaged at all levels of the market. The industry is still populated by ECNs that target specific segments – I think that will change and I want LMAX at the forefront of that change.”
“We’ve built real momentum and traction over the past 18 months and we will continue on that track. We have improved the breadth of products we offer, enhanced the technology platform and moved to a new data centre, which gives us 10 times more scale than before, and we have built up a distribution network, which is where the traction has started to come from,” Mercer explains.
He continues, “In 12 to 18 months’ time we will look to extend our geographic coverage and market segments. We are seeing traction from the Asia Pacific region and from retail brokers and money managers. If Asia Pacific becomes more important to us, then as part of our growth capital we will look at having a presence or running an exchange there. Likewise, North America with its Dodd-Frank and swap execution facility regulations is a huge opportunity for us as an MTF. At present we cover the retail and institutional space, but there are other segments that we will look at in the future.
“We have a clear strategy and roadmap to build LMAX Exchange into a leading FX venue globally in three to five years,” he adds.
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Media Contacts
For further information please contact:
LMAX Exchange (London):
Barbara Pozdorovkina T: +44 20 3192 2510 E: [email protected]
About LMAX Exchange
LMAX Exchange Group is a dynamic, visionary and award-winning financial technology company. Recognised as one of the UK’s fastest growing technology firms, LMAX Exchange is leading the transformation of the global FX industry to transparent, fair, precise and consistent execution. Operating one global marketplace for trading FX, metals, indices and commodities, LMAX Exchange delivers open access, transparency and a level playing field to all market participants.
LMAX Exchange Group offers all clients the ability to trade on LMAX Exchange central limit order book, driven by streaming no ‘last look’ limit-order liquidity from top tier banks and non-bank financial institutions. Servicing funds, banks, brokerages, asset managers and proprietary trading firms, LMAX Exchange offers an anonymous, regulated, rules-based trading environment, order execution in strict price/time priority, and access to real-time streaming market and trade data, enabling all market participants to control execution quality and total trading costs.
Offering a comprehensive range of instruments and ultra-low latency execution, LMAX Exchange operates a global FX exchange infrastructure with matching engines in London, New York and Tokyo.
LMAX Exchange - a unique vision for global FX.
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LMAX Exchange is a trading name of LMAX Limited, which operates a multilateral trading facility, authorised and regulated by the Financial Conduct Authority (firm reference number 509778) and is a company registered in England and Wales (number 6505809).
LMAX Global is a trading name of LMAX Broker Limited which is authorised and regulated by the Financial Conduct Authority (firm reference number 783200) and is a company registered in England and Wales (number 10819525).