Multilateral trading facilities: Turquoise dives in at dark end

Turquoise, a new multilateral trading facility rival to European exchanges, is set to launch limited live trading on August 15.

Backed by some of the most powerful investment banks, the MTF plans to hit the ground running, with 60 to 80 clients at launch and liquidity commitments from its nine shareholders.

It also plans a rapid roll-out of the full 1,500 securities across 14 markets that it plans to trade over just three weeks, compared with the more gradual approach of rival MTF Chi-X, which has been adding markets gradually since launching 15 months ago.

Turquoise will offer trading in all 1,500 stocks on its dark pool – its non-displayed matching engine for large orders – and also open order book trading for the 300 most liquid stocks.

The key difference between Turquoise and both rival MTFs and incumbent exchanges will be the interaction of orders between its dark pool and order book that it hopes will increase matching rates and offer better execution. Orders entered into the dark pool will have access to the order book’s trading volume, improving match rates and at the same time enabling smaller orders to trade at improved prices when hitting a dark order inside the spread.

"Turquoise will be a destination for virtually every bank in Europe that has a significant direct market access business," boasts Eli Lederman, chief executive of Turquoise. "The liquidity commitment we have from our shareholders to send both buy and sell orders means that we expect to have an order book that looks very much like an incumbent exchange’s right from day one."

Tariffs for executions on the dark pool will be premium while passive orders on the visible order book will receive a rebate.

Turquoise’s limited launch will come just weeks before that of a new pan-European MTF from Nasdaq OMX and a couple of months before that of established US platform Bats, both of which plan to offer high-speed order books, more similar to Chi-X.

Both platforms have selected Fortis’s European Multilateral Clearing Facility (EMCF) for their pan-European clearing and settlement, which is already up and running with Chi-X, while Turquoise is launching with a system from the US clearing house DTCC called EuroCCP, with settlement by Citi.

While these MTFs offer little new in terms of innovative market structures, concentrating on the straightforward business of high-speed, high-volume order book execution, another new MTF, backed by the London Stock Exchange and based on Lehman Brothers’ technology, promises something different.

Deep thinking

Billed as a "next generation" and "intelligent exchange" the new MTF, called Baikal, after the world’s deepest lake, wants to do far more than simply match buy and sell orders. According to its developers, Baikal will be able to understand the strategy and intentions behind its clients’ orders and execute them accordingly.

Rather than buy or sell 1 million shares of company X at price Y, Baikal’s developers imagine a typical order more along the lines of buy or sell 1 million shares of company X over the course of the day, never being more than one-third of the volume and 10% of the volume at the close. Baikal would receive the instruction and execute the order, like an algorithm, according to whatever parameters are set, routing trades externally when appropriate to whichever venues offer the best prices for how the trade is being broken up and executed.

The technology will be based on Lehman’s highly successful LX dark pool, which matches as much as 20% of Lehman’s trades internally and which has helped make the bank the number one trader by both value and orders on the LSE, the number one by orders and number two by value on Euronext and the number two by orders and number four by value on Deutsche Börse.

"Imagine if an exchange or MTF could understand how its clients wanted to do a trade and could organize itself around that" John Lowrey, Lehman Brothers

The LSE will be the majority partner in the venue and there are plans to open the capital structure to other investors. Lehman will earn a licensing fee for its technology. Baikal aims to launch in the first quarter of 2009.

Swiss cross

SWX Europe, a London-based subsidiary of the Swiss Exchange, announced in July that it had signed up 10 investment bank clients for a new dark pool for crossing large blocks of Swiss blue chips that it has set up in cooperation with Nyfix Euro Millennium, a pan-European crossing network launched earlier this year. The launch clients include ABN Amro, Citi, Credit Suisse, Deutsche Bank, Instinet, Lehman Brothers, JPMorgan, Merrill Lynch, UBS and Vontobel.

Euronext plans to launch its own dark pool in September, and its parent company is said to be in discussions with Liquidnet, a leading crossing network with a negotiation model, about collaboration.

Of the major incumbent exchanges, only Deutsche Börse has yet to announce plans to launch a dark pool of its own. Demand for such trading has increased in recent years as fund managers’ average position sizes have grown, thanks to consolidation, and average trade sizes have fallen, making it harder for traders to execute the large blocks they need to trade.

Beset by fragmentation

All this competition promises much for those that can afford the technology needed to exploit it. Smaller brokers, however, are already getting exasperated with the fragmentation, particularly of market data, and are struggling to make sense of it all. For them, things looks likely to get worse as the trading environment becomes more complex. Many in the industry are expecting them to lose more market share to the top-tier brokers.