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THINKING BIG – David Mercer

Profit & Loss, August 2013 – Colin Lambert talks to LMAX Exchange CEO, David Mercer, about the venue, the industry and how to compete.

Colin Lambert: LMAX Exchange has made something of a stir in the industry and is regarded in some quarters as the fastest growing venue out there – what has caused this?

David Mercer: I think we bring something different to the party in terms of our model. We are an MTF (multilateral trading facility) regulated in the European Union and our model operates with no last look as standard. This promotes firm liquidity in the order book and superior execution for participants because rejection rates – which are an increasing problem in the industry – simply do not exist.

Our technology also differentiates us because of its superior performance and speed – average execution latency is less than three milliseconds which means people can price and execute with more certainty and accuracy. The bottom line is you just get done, you never get rejected and re-quoted.

CL: Forgive me for saying, but is that really different? It’s a phrase I hear a lot and it is rarely backed up with facts.

DM: In terms of how you trade, I accept it is very difficult to be different, but you need to look at the business in its entirety. Not many trading venues offer no last look, and are a regulated MTF offering that level of technology – and even fewer have the mix of participants LMAX Exchange can offer.

We offer the same quality of execution for all participants, from the minimum $10,000 trades upwards – it doesn’t matter who you are, you are treated in the same fair, transparent manner. The same order book is shown to professional traders and institutional clients. That inclusiveness is, I believe, different.

CL: It seems you have a broader spread of clients than previously when we have spoken – is that what is behind the growth?

DM: It has to be, without growth in client numbers you will top out at some stage. We are gaining some serious traction in terms of our Professional venue and our Interbank venue, which was launched earlier this year, is also attracting good volumes.

In terms of our client spread, six months ago about 50% of our volume was from our initial niche market, the retail brokers. Our volumes have increased significantly since then, but that segment’s share of our volume has gone down to 25% – this highlights how the model is attracting wider attention.

CL: So who are the new players?

DM: We have had a good deal of success with small to medium institutional players, professional money managers and prop trading firms that might be seen as boutique – the two or three people in a room that think they know enough about the markets to make some decent money.

We have clients in 55 countries and we have a pipeline of banks looking to be liquidity providers to the venue – it is a tremendous vote of confidence in what we have done so far.

CL: You mentioned the LMAX Interbank venue, which launched in February, how is that progressing?

DM: Volumes are growing strongly; obviously it is from a small base, but we are happy with its progress and it’s on track with our forecasts.

CL: And you have been quite open in stating that LMAX’s fortunes are not tied to its success.

DM: Absolutely, we responded to client demand in creating it, but all it really does is leverage our existing technology and bank relationships. That is not to say we are not keen to see it succeed; we are, and the early signs are encouraging.

CL: The interbank space is so crowded, I must confess to being surprised that things are progressing so well. Why is that?

DM I think the API is empowering, it makes it easier for people to connect up to another venue. Fragmentation is a reality and as the algos that handle execution improve so they enable participants to connect to more venues. This represents a good opportunity for us.

From there, the story doesn’t change. People in the interbank market are attracted by our model and it is obligation-free because it is an interest only venue. The same values of fairness and excellent technology work in the interbank space as they do in our Professional market.

We are about to launch an Institutional trading venue which we hope will attract the same level of interest. Again, we are leveraging existing technology and staying true to the fairness model, and we are being told by our customers that they would welcome the new venue. Institutional clients want no last look and the benefits that brings and liquidity providers are keen to price that type of flow in a fair and transparent environment.

CL: When do you expect the new venue to go live?

DM: It will be ready in the next three months and we will see how it goes, but again, we are not betting the company on it, we are providing a different venue on the same technology framework.

CL: Do you consider yourself a technology company or an exchange/broker?

DM: We are probably both. We have added serious headcount in the past year and I would say more than half the firm is technology-focused. We have deliberately chosen to invest in technology because we consider that building for the future. Our new venues utilise the same technology people and we have a fortnightly release cycle across all venues. That scalability of our technology gives us opportunities.

On the other hand, our trading model is attracting aspirational investors who are depositing money with LMAX Exchange as a regulated MTF and a broker. This means you don’t need a prime broker, if you have funds and trade on our venue, we will clear it for you. I would stress though, we are not a retail broker in the traditional sense of the phrase – we don’t assume risk or trade as a principal in any way – we merely offer access to the MTF for matching trades.

CL: So how do you grow further from here? You have mentioned in the past you cannot compete with the distribution capabilities of some of the big players – is there anything you can do about that?

DM: We certainly lack the distribution capabilities of some of the established big players – would I like to have that sort of firepower? Of course. The fact is though, I can’t spend that sort of money to build such a distribution network, so we have to grow on the back of our technology.

We currently have a matching engine in London LD4, and it would make sense to have another in New York and probably another in Asia – that would help build our business further. The key is growth capital – if investors can write a bigger cheque that will enable us to grow faster, then great. If not, we’ll grow the business organically. I want us to establish a presence in NY4 and TK3 as well as LD4, there are set up costs, but it would help us build geographically.

We cannot compete pound for pound on a distribution basis so we have to run a smarter business that utilises our capital intelligently and controls its costs. We need to expand geographically but we need to have a degree of patience as well. The big players in this space will always be big, because they have the distribution networks, but I would argue we have the technology advantage and in today’s market that is very important.

CL: It sounds to me as though you are making an argument for consolidation – where big players invest in newcomers?

DM: There will be consolidation at some point, it is inevitable, but I think we have quite a way to go yet before we see that. There is always going to be someone new in the industry and the established players will always run the rule over them to see if they have the potential to upset the equilibrium.

This is not just specific to financial markets technology, look at Facebook. I don’t use Facebook but I love Instagram – Facebook saw the value in Instagram and bought it, likewise Twitter bought TweetDeck.

In our space the big players are not thinking about this yet, but as one or two or three of the newcomers are successful it becomes a potential issue. We are not looking for an exit, M&A deals don’t always work after all, but it is only natural to think how good it would be to have our technology and model with a huge distribution network.

If we are to grow organically, or with some growth capital, then greater distribution will inevitably be a part of it, I just don’t think it will be the whole story – our technological excellence will lead.

CL: It is refreshing – or perhaps more accurately a reflection of the current mood in the industry – to hear someone talk about growth without mentioning new players to the industry, particularly from the HFT segment. Optiver, a high frequency trading firm, was one of your first market makers on the Professional venue but you seem to have avoided some of the challenges faced elsewhere from HFT. Is this through ignoring the sector or something else?

DM: You’re right that Optiver, along with Goldman Sachs and JP Morgan, were our initial liquidity providers, but they have been joined by 11 other liquidity providers now, which proves, I think, that LMAX Exchange is a ‘clean’ environment.

The bottom line is we have market makers from bank and nonbank sectors but all adhere to the rules and cannot ‘game’ the venue. We are very open and transparent, our rules are published for all to see on our website – and they do not permit ‘gaming.’

If HFT firms, as defined by the Bank for International Settlements in its paper in late 2011 (see Profit & Loss, November 2011), want to trade on LMAX, they will be on the Institutional venue, not the Professional, and they will be expected to adhere to the rules.

If we get complaints or identify any behaviour that can lead to a deterioration in conditions on the venues we will act – we will turn people off. And that is not just non-bank firms, the same rules apply to all participants – banks included.

There is no value for me, as a provider, or for the industry as a whole in bad behaviour such as ‘flashing’ or latency arbitrage, so I insist we police it well. Unfairness or providing an opportunity for a particular strategy is not what we are about.

CL: You seem quite passionate about that, it’s clearly important to you.

DM: It is important – it’s borderline paranoia! Seriously, it is about maintaining a fair balance and keeping everyone happy – both takers and makers.

We have to be alert to unfair or bad behaviour because both can lead to a deterioration in the quality of execution and depth of book. You are always going to hear people say they lose money, both takers and makers, but you have to be alert to why it is happening. Sometimes it is the natural course of a market, but we want to make sure that is what it is – and not bad or unfair actions.

I think we are getting it right, we are okay, but we are not complacent. We built a model around fairness and vigilance and we are determined to maintain those values.

CL: At Forex Network New York you suggested the Professional venue could allow execution in terrifically small sizes – I think $100 was mentioned – and I was quick to disagree with you, as is my wont! How do you marry the ability to trade in small size with best execution?

DM: I do think it possible to create an order book that carries all interest from $100 to $100 million. The cost of pricing in both is the same so it helps the market to have it aggregated, which is what we do, with a single counterparty. The key is no last look – people cannot post prices broken down into small amounts and then reject trades to avoid doing that amount – which is what I believe the argument you were making in New York was all about? We show aggregated liquidity and if the bid is for $20,500,300 and you hit it for that amount – that is what you get done.

CL: I think my point was about those firms with predictive technology based upon posting a price in small to sniff out a large order and then marking the market away from that order.

DM: I accept that for some particularly large orders then a public, transparent marketplace is not the best venue to execute on, that is why the bank-client relationship is so important – it allows the transfer of large risk from a relatively small institution that is easily identified in the market to one that is much larger and harder to spot.

To your question though, I would say again – look at our rulebook. If we suspect that is what people are doing, we will investigate and we will block them.

It is also important to remember that there are ways for people to mask their larger orders – the technology doesn’t work one way. Clients and banks alike can place an iceberg order on LMAX which refills in 1.5 milliseconds, meaning their order is in the market but not visible to anyone other than a genuine seller or buyer.

CL: So best execution and transparency can work together?

DM: In the right environment – a fair environment – yes they can. The phrase ‘best execution’ has lost its context to a large degree as different sides of the industry have turned its meaning to their advantage.

You could ask, what is fair about stop hunting? We may not want to accept it, but it still goes on and is anything but best execution. Is it fair to suddenly go 10 points wide for a second and have stops taken out?

CL: How do you protect against that?

DM: It’s difficult, there is no doubt about it. On LMAX Exchange we have the concept of the ‘untrusted spread’. If spreads go too wide it ‘greys out’ and nothing is done until we identify if there is a problem. What happens though if something has happened and liquidity providers have genuinely gone wide? Especially if people have take profits there and not stop losses? You are damned if you do the trades and damned if you don’t, especially if the market reverts to three or five pips wide a minute after being 30 wide. The only way to deal with the problem is to have an established, publicly available rulebook that ensures the same treatment for everyone and that everyone knows unequivocally what will happen in these circumstances.

CL: On the subject of fairness and transparency, do you have any opinion on EBS’s recent announcement that it will seek to certify aggregators that use its liquidity?

DM: In principle we support it because it is a good step. We have to support it because the same rules have been enshrined in our venue from the start – in fact I would say we actually led the way on this. Our rules state that if there is a price improvement or an inverted spread, the customer gets the benefit – no-one else. They also promote the any-to-any concept, trades are not prioritised according to anything but when the order was entered and where it sits in the order book.

CL: Is it frustrating to you that people didn’t recognise you were there first?

DM: A little, but now we have an unregulated venue seeking to build a fair and transparent framework that has existed in our regulated environment for several years. Sometimes you do feel as though some of the established giants could use a little humility and recognise others’ leadership in certain areas, but at the end of the day it is a good initiative because it will increase fairness and transparency – and that makes the market a better place.

CL: What other areas do you feel the industry could improve in?

DM: I am a big believer in the power and value of transaction cost analysis (TCA) and I would like to see LMAX Exchange lead in that field by putting something out there that says ‘this is best bid/offer in those sizes at that time’ for example. It is doable certainly, and we need to think about the different needs of different people and provide data across the market.

For example, venue XYZ could be better in $20 million than venue ABC but the latter is better in $3 million. Accurate TCA takes both into account – where is best execution in my amount not just a random rate for a random amount? TCA is very much a buy side tool in other markets where customers use it to build better execution models, I think the same can happen in FX.

My dilemma is how do we align our firm orders with others’ tradable quotes? What is the true level of liquidity on other venues? It is also important to include single dealer venues in this – for good TCA you need a picture across the entire market, not just a segment, especially one with last look.

I am happy to work with everyone on this to create the best possible TCA because it will benefit the industry and lead to higher volumes for everyone. If we can clarify for customers exactly when and where they should execute their trades, for example in certain time zones for certain currency pairs in certain sizes, we are providing a real value add for the end user.

CL: We started by talking about your growth, can we close quantifying it?

DM: Sure. I think it is important to be pragmatic about our growth – we know we are not in the same league as the very big players at the moment. In May and June we did about $125 billion each month. Across eight quarters we have compound 85% growth – we did about $74 yards in the second quarter last year and will do something like $340 yards this quarter.

On the customer side, we now have 11 banks live trading on the Interbank venue, with an additional four signed up and we are regularly hitting $600 million per day. We know these are small in some contexts, but they are heading in the right direction and as more participants start to trade they should continue to head north.

CL: So you remain happy with your business plan?

DM: Very much so. The first two years have been tough, but we have achieved what we set out to do; indeed we could look back and see those years as the toughest. We have hit every KPI (key performance indicator) we set and we are slightly ahead on the Interbank venue.

Sometimes we get too focused on numbers in this business, it is all very well doing 100-plus yards a day but what is the cost side of the equation. We are comfortable with where we sit there.

CL: And the ambition remains…?

DM: I want LMAX Exchange to be the premier venue across geographies and customer segments in three-to-five years’ time. I think we can achieve it through our technology and by adding to our distribution capabilities. If we continue to achieve that happy balance of keeping our customers happy – which is difficult don’t get me wrong – then our volumes will grow and so will our customer numbers.


David Mercer is the chief executive of LMAX Exchange, Europe leading MTF specialising in FX. He has more than 20 years’ experience in the derivatives industry and an extensive expertise in the leveraged FX business. Prior to joining LMAX Exchange, he held senior executive roles at IFX Markets and Saxo Bank (Synthesis Bank) in London, Geneva and Sydney. Mercer started his career at CSFP and Credit Suisse First Boston focusing on fixed income derivatives, primarily as the business manager in the emerging markets division.

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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 Group is the holding company of LMAX Limited and LMAX Broker Limited.

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).