Read time: 12 min


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

CL: Do you consider yourself a technology company or an

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

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
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 non-
bank 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. 

Paul Gogliormella

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