Turquoise CEO Warns Low Trading Volumes May Hasten Trading Venue Consolidation as MTFs Gain Liquidity

Originally published March 30, 2009

Over the past two years, developers of alternative trading venues known as multi-lateral trading facilities (MTFs) have been mounting challenges to the established major European exchanges under the commercial competition in trading enabled by the European Union’s Markets in Financial Instruments Directive (MiFID). Chi-X was the first MTF to become operational, followed by several others. The leading MTF contenders include Turquoise, which is backed by nine major global investment banks. Turquoise aims to differentiate itself with features such as its Dark Pool Aggregation Service, scheduled to launch in May, and a midpoint match, which will begin in mid-April. Turquoise is also considering the possibility of adding asset classes other than equities to its trading platform. Global Investment Technology spoke with Eli Lederman, Chief Executive Officer, Turquoise, based in London.

GIT: What’s your perspective on the increasing competition in the European trading arena?

EL: It’s going to be good for trading, for clients and the end-beneficiaries of trading, the investors. Because trading is getting more efficient, there is significant execution performance improvement and price improvement; there’s new functionality. So the competition is a significant positive.

GIT: How would you contrast the rise of MTFs under MiFID with the rise of ECNs after Reg ATS in the US during the late 1990s? What are the similarities and differences?

EL: As a similarity, people see a commercial opportunity in starting and running an MTF, just as happened in the US where the opportunity motivated entrepreneurial people to start ECNs. The major difference is the technological readiness here. In the US, it took awhile as it was all new. Now it’s been done before so, while everything here started later, we anticipate it will happen on an accelerated cycle. Connectivity and smart order-routing used to be technical challenges but now are largely yesterday’s news. Another significant difference is that there isn’t a single clearing and settlement infrastructure as there is in the US, so the integration requires more back-office and operations work than front-office and trading work. There are infrastructure costs to this fragmentation, but that’s more of the issue than the movement of liquidity on the front end of the process.

Another issue is that the overall trading volumes are declining quite significantly [because of the current economic downturn], so as the whole landscape becomes more competitive, that competition is over a smaller opportunity. Unless this changes quickly, the proliferation of venues that swept the US will not extend so far in Europe, and consolidation of the venues in Europe will happen faster than it did in the US.

GIT: Turquoise has the backing of risk-taking brokers. Given the extraordinary global recession and drop in volumes, what uncertainty does this place on future plans, as well as MTF competition?

EL: I don’t think there’s any uncertainty, although it’s made the exercise harder. Everything takes longer in 2009 than it would have in 2007, to be sure, because resources and priorities are somewhat scarcer on the bank and broker side. There is very intense motivation to ensure that competition in Europe is here to stay, along with all the benefits of that competition, including more liquidity, more choice and better economics. The lower overall volumes definitely are going to fan the flames of competition, but at the other end of the telescope, you could say that there could have been more entrants and more competition if the opportunity hadn’t become a greater challenge.

GIT: What would you tell those who say Turquoise has lost first mover advantage to Chi-X and also faces tough competition from exchanges?

EL: Chi-X clearly began more than a year ahead of us, and that was an advantage because it was a better environment to begin something in, but also there are some advantages of being second mover, in that our uptake has been faster in part because of the changes [Chi-X] forced through the system, such as firms learning to connect to a second venue for every market, making it easier for them to connect to a third venue. The exchanges have acted in ways that may be a response to MTFs, by adjusting pricing, for example. Some exchanges have announced that they are going to add new functionality and services like dark pools. There was little innovation in functionality historically, but that may be changing as they adjust to a more competitive landscape. It is difficult to generalize about all the incumbent exchanges. They have had different responses, ranging from no response, to becoming somewhat more proactive.

GIT: Are firms less willing to spend capital to connect to multiple venues?

EL: Although it sometimes takes longer, I’m pleased with our uptake and it’s in line with what we expected when we planned last year in a very different market environment. But we do hear that every new connection has to be justified on an economic basis, that they aren’t free and starting and maintaining them must make economic sense. We hear that banks are becoming more discriminating about what they pay for and what they live without, and we are hearing for the first time that some venues are being switched off for not making the grade.

GIT: Will MTFs siphon away liquidity from the primary exchanges? What will be the sources of new liquidity?

EL: Yes, they can and they definitely are. Some of the liquidity on these platforms is clearly market-making activity that may not have existed with the high frictional cost of trading on the incumbent exchanges and the inefficient, expensive clearing facilities around them. But a very significant amount of the trading on MTFs now is natural liquidity that would otherwise have been done on the exchanges. If you see the incumbent exchanges’ market share dropping down now to 85 percent of order-book consideration, that trend maybe has taken a little bit of a breather, but is going to start again in earnest and be more severe for the rest of the year. There are a number of very significant specialist trading firms that have been drawn to the new economics of trading in Europe. The price improvement they provide will draw business away from the historic exchanges.

GIT: Could you share some insights on what are the drivers of electronic trading innovation in Europe?

EL: The fragmentation is good for competition, but there also has to be the ability to find liquidity in institutional size. What we’re doing with dark liquidity is aiming specifically at helping people make that discovery. That’s what drives the innovation — the demand and the commercial opportunity behind that.

GIT: Are MTFs enablers of best execution? Does which MTF you select or ignore also impact best execution?

EL: Definitely. People are now independently reporting on price improvement derived from the MTFs. According to research just published by Equiduct [as of March 23], more than a third of trades in Europe would have gotten a better price if they accessed the liquidity on MTFs. There is also every indication that there is more price improvement to be had. MTFs offer more modern technology with higher capacity, lower latency and real price improvement, largely motivated by the maker-taker model, that attracts some of the new liquidity providers. That maker-taker model is generating prices that represent real price improvement for traders and their clients.

GIT: How do you see the MTF competition playing out? Will it be a collision course with exchanges, or something different than that?

EL: It is probably a collision course to some degree. We have a pan-European model and are really very focused on reducing the country-by-country fragmentation that has characterized European trading forever. Some of the exchanges will have to look at what they can do more effectively cross-border. It’s difficult not to see this as competition directly between MTFs and exchanges. Exchanges still have the overwhelming majority of the market.

GIT: What is the importance of clearing to the success of MTFs?

EL: The MTFs catalyzed the creation of pan-European trading capabilities and clearing services, through EuroCCP and EMCF [European Multilateral Clearing Facility]. Two years ago, if you said there would be pan-European clearing, no one would have believed it. Now the agenda is restructuring for interoperability. Business from Turquoise could be cleared on a different platform at some point, probably even this year.

GIT: If MTFs succeed, does that mean vertical silos will lose clearing revenues?

EL: They will have to, because people look at the total cost of trading — that’s trading, clearing and settlement. Now we all use the same settlement [arrangements], but if a firm doesn’t have the lowest cost for trading and clearing, it will be in trouble. It may have to decouple trading and clearing if it cannot clear at the right level, and use a different facility. That decoupling is inevitable and will be a great positive for market participants.

GIT: Will MTFs become proactive sources of price discovery?

EL: Definitely. It’s already beginning and it will just accelerate. MTFs have to get to a certain critical mass in market share and people won’t any longer be able to hide behind the fact that many stocks don’t effectively have a primary anymore. In some small number of months, people will say that about entire markets. Once that happens, how can you justify the designation of one market over another one as a reference? It just won’t make sense and investors are ultimately going to demand that the market rationalize its concept of primacy.

GIT: What might the picture look like in three years?

EL: We’ll be at the other end of the cycle. There won’t be any single country platforms in Europe anymore. The single country systems will have morphed or disappeared as the single-most important thing, and there will be a considerably more open clearing and settlement environment. Competitive pressures will cause this — and political will.



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