INVESTOR SERVICES: The colour Turquoise

Project Turquoise, the bank-backed alternative trading platform, has caused much anticipation among the trading community. Nik Pratt talks to Eli Lederman, CEO (pictured) about what it will mean for fund managers …

“A year ago many fund managers were wondering what Turquoise was going to be,” admits Eli Lederman, CEO of Project Turquoise, which is a new trading venue designed to compete with traditional stock exchanges. “Would it be something only for the brokers?”

This is not surprising given that the project is backed by broker/dealers. Inspired by the market liberalisation sought by the EC and encapsulated in the MiFID regulation, seven investment banks – Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley and UBS – came together to develop a pan-European trading platform that would rival the established exchanges and offer traders an alternative execution venue.

Two further banks – Société Générale and BNP Paribas – joined the consortium, various technology partners were selected and a management team was recruited, led by Lederman, a former Morgan Stanley executive who played a key role in establishing the bank’s US equity electronic trading business before moving to London in 2001. The platform’s launch is scheduled for a three-week period between August and September this year and will launch on 5 September  with over 1,500 securities covering 14 countries.

Lederman continues: “There was possibly not enough information out there so we have conscientiously engaged with the buy-side community to let them know what we’re doing.”

Diverse fund pool
Turquoise now has a buy-side advisory panel consisting of 12 representatives from the trading desks of fund managers who are helping to design the business model, says Lederman. It is a diverse pool of firms he says – from traditional asset managers to hedge funds and covering the Nordic regions as well as the UK and mainland Europe – but the uniting factor is that they have been most actively involved in trading developments for the buy-side and are keen to support new industry initiatives. “They recognise the benefits we are going to bring to the market in terms of competition – better execution for fund managers and their clients, and more innovation.”

But for every firm participating in advisory panels and steering groups, there are others less willing to believe in the supposed benefits on offer and are wary that the reduced trading costs and better spreads that Turquoise and other MTFs boast of in comparison to the exchanges will not make their way onto their balance sheets quite as quickly as is imagined. The inefficiency in trading and settlement and the extra investment in technology such as smart order routers could both delay any instant savings to be had. But Lederman disagrees and sees no reason why there should not be instant benefits and the only delay will be in the process designed to measure these benefits.

The other message coming from unenthusiastic fund managers is that this is all a broker issue rather than theirs. Execution quality is undoubtedly a big focus for banks and brokers, says Lederman, but the fact it is becoming an increasingly competitive area for the sell-side, creates an opportunity for the buy-side to be the beneficiaries of this competition and the smart routing and best execution that their brokers undertake. “So over time I think fund managers will appreciate it because they will be receiving their execution reports and understand what is happening behind the screens.”

Such has been the anticipation around Turquoise that many people in the market expected it go to live much earlier, possibly around the time that MiFID was implemented in November last year. Lederman, however, refutes any suggestion that Turquoise has been subject to any delay, stressing that it has taken time to take Turquoise from its early ‘project’ status to being a fully staffed and operational company.

Execution mode
“The stories of delays are part of the past. There was a time when Turquoise was being operated as a project by a consortium. We took a very conscious decision last September to reconstitute Turquoise as a company.” Turquoise is now in execution mode, says Lederman. It is fully staffed and ready to operate and “hitting every date in the plan”.

By contrast Turquoise’s main rival – the Instinet-owned Chi-X – launched early last year, in time for the introduction of MiFID, and has managed to build up some respectable statistics in this time. Does this mean that Turquoise will be playing catch-up when it does launch or will it have the benefit of a year’s hindsight and the ability to take into account any unexpected developments that may have occurred in the post-MiFID securities market?

“When there are big changes to a market it takes a while for the potential impact to be realised and we are very well situated,” says Lederman. “There has been another MTF that has launched, albeit one with a different business model, but it has paved the way for us and clearly demonstrated that it is possible to move trades from one venue to another.”

The ‘other’ MTF that Lederman refers to is, of course, Chi-X, whose chief executive Peter Randall featured in this magazine’s previous issue. The sparring between Randall and Lederman has been one of the more entertaining features of the conference circuit in recent months. At this year’s Trade Tech event in Paris, Randall’s boss, Instinet chairman Tony Mackay said: “Chi-X is a business, Turquoise is a project.” Meanwhile Lederman noted that “in a competitive environment you have to play offence every day”.

Besides Turquoise and Chi-X, there will also be offerings from US-based Bats Trading and from Nasdaq OMX, which is a collaboration between the US and Swedish exchanges. Chi-X has the advantage of having launched already, Bats Trading has been operating an alternative trading platform in the US for some time and Nasdaq and OMX have an exchange background to call on. So what does Turquoise have in its armoury to help it compete in Europe besides the backing of nine of the most influential investment banks in the market?

Dark pool
One of the differentiating factors for Turquoise is the creation of a dark pool, the first “credible” dark pool for institutional-size orders, says Lederman, and one which will reduce market impact and improve execution quality. Dark pools have been gaining in popularity with those buy-side firms interested in reducing their market impact and several investment banks, as well as the crossing networks like ITG Posit and Liquidnet, have created their own dark pool.

Where Lederman believes the Turquoise dark pool will be different to the single bank offering is in the potential size of the cross-flows with it being accessible to all of the 60-80 member banks expected by the time Turquoise goes live. Secondly, MiFID is very much about encouraging more transparency and the directive specifically provisioned for this type of dark facility for large orders. The minimum order for Turquoise’s dark pool is e500,000, says Lederman, which is up to 20 times more than the average trade size.

Another feature that Lederman believes sets Turquoise apart is its clearing and settlement partner Euro CCP, the European venture of US-based Depository Trust Clearing Corporation. Whereas Chi-X, Nasdaq OMX and Bats Europe have all appointed Fortis Bank to handle clearing, Euro CCP will act as the single pan-European clearing platform for all Turquoise trades. The European market has a very fragmented structure at the moment, says Lederman and the combination of Turquoise and Euro CCP both offering pan-European platforms this will help to navigate that fragmentation.

Lederman draws a parallel between the formation of several new pan-European clearing and settlement platforms and the emergence of the new MTFs, in that both trends have resulted from a desire to challenge the market’s established but inefficient conventions. “A year or two ago clearing and settlement in Europe was as fragmented as trading. It was thought it would remain like that because that was the way things were done. But then you have these upstart platforms come in, like Turquoise and Chi-X, that are not prepared to accept the status quo and believe that things can be done better with new technology and some hard work and perseverance.”

The selection of EuroCCP also adds another US element to Turquoise, alongside Lederman himself and reflects a growing trend for players in the much fragmented US securities market to try their hand in Europe – be they clearing platforms, traditional exchanges, MTFs or dark pool providers. Is Europe heading the same way as the US? Will there be too many new ‘upstarts’ in Europe?

“There are many, many of these alternative platforms and dark pools in the US and I think Europe is looking at the US market structure and thinking that we really don’t need that many platforms so will be looking with a critical eye at any new entrant because fragmentation for fragmentation’s sake is not a positive thing,” says Lederman.

In the long term he believes the likely scenario is that there will be an incumbent exchange and two MTFs for most major markets. As for Turquoise’s own future plans Lederman does not rule out expanding the platform to other geographies and new asset classes but right now the focus is wholly centred on launching successfully and having a profitable first year. Meanwhile, Lederman stresses that fund managers do have a role to play in all of this and should not simply sit back and wait to see what happens.

They should continue to be vocal about what they expect from the MTFs and how they want the market to evolve, lest it should evolve in an unfavourable way. “It’s important for fund managers to be actively involved in the design of the market structure. Without that engagement between the buy and sell-side and technology providers, we may find that we drift towards a market structure that is not optimal for trading.”

©  2008 funds europe



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