LSE’s Turquoise deal: more than an olive branch to banks

The London Stock Exchange’s (LSE) plan to buy Turquoise is unlikely to be driven solely by a desire to appease the multilateral trading facility’s founding banks, but the plans of those shareholders and liquidity providers are key to the long-term success of the deal.
By None

The London Stock Exchange’s (LSE) plan to buy Turquoise is unlikely to be driven solely by a desire to appease the multilateral trading facility’s founding banks, but the plans of those shareholders and liquidity providers are key to the long-term success of the deal.

Xavier Rolet, who took over as the LSE’s CEO from Clara Furse in May, has made it a central plank of his mission to heal the rifts between the bourse and its large investment banking clients, seven of which formed Turquoise in 2006 in response to high exchange trading fees. Rolet’s client-centric focus, coupled with the fact that the LSE already has an MTF licence – for its Baikal project – and a new technology provider, the recently-acquired Sri Lanka-based MillenniumIT, has prompted speculation that the LSE is trying to draw its clients into a closer relationship, in part by taking the unprofitable trading venture off their hands.

But some are unconvinced. “Neither firm is a charity and they are both accountable to shareholders so I question that view, and if that is the case then it is several years too late,” Niki Beattie, managing director of UK consultancy The Market Structure Practice and a former managing director at Merrill Lynch, told “Liquidity provision is not necessarily the strength of the investment banks and Turquoise’s shareholder list generally excludes the high-frequency companies that the LSE now needs to improve relationships with in order to create and attract liquidity.”

Last Thursday, in response to press reports, the LSE issued a statement confirming it was in exclusive talks with Turquoise which could lead to a transaction. However, further details, such as the terms and the exchange’s rationale, have yet to emerge.

The announcement surprised many, not least because it closely followed the decision to buy MillenniumIT and comes just before the expected launch of the order book portion of Baikal, the LSE’s dark trading and liquidity aggregation service, in Q4.

“I am quite surprised by the announcement because, unless the LSE has got some substantial liquidity commitments from Turquoise’s shareholders, it is not really clear what it is buying,” said Beattie, one of the architects of Turquoise while at Merrill Lynch. “The LSE doesn’t need an MTF licence, and while it does need new technology, it has just bought Millennium IT. In addition, Turquoise’s technology is provided by Cinnober, so it would just be getting a licence.”

However, Turquoise does have other assets that the LSE covets. The acquisition would grant the exchange an instant platform for offering a pan-European equities trading service. “It gives the LSE a pan-European shop front with real order flow, which is very important to it,” says Steve Grob, director of strategy at trading technology firm Fidessa.

In addition, Turquoise’s TQ Lens dark aggregation service, its mid-point non-displayed book and large-in-size dark trading capabilities would all either add new functionality or accelerate the delivery of Baikal. The already-operational TQ Lens, for example, connects eight liquidity providers, among them Bank of America Merrill Lynch, Citadel Securities and Citi.

“If the LSE can agree a good price, then these features could be very attractive,” said Andrew Mitchell, exchanges analyst at boutique investment bank Fox-Pitt, Kelton. “An acquisition would also prevent someone else buying Turquoise and potentially running parallel functionality to the LSE.”

But it is unclear, absent any liquidity arrangements from the founders, how much dark liquidity would migrate to the LSE with the purchase. Recent client trading figures for Turquoise seen by theTRADEnews indicate that around three-quarters of Turquoise’s dark trading is conducted by just five shareholding banks.

The acquisition could also improve the LSE’s competitive position in the clearing space. Rolet is keen to grow Cassa di Compensazione e Garanzia (CC&G), the clearer it acquired with the purchase of Italian stock exchange group Borsa Italiana in 2007. The CEO indicated last month a desire to shift LSE’s clearing away from LCH.Clearnet towards CC&G in the medium term.

“If you are trying to build a vertical clearing model, one could argue that buying Turquoise would potentially take out a clearing competitor in EuroCCP,” said Beattie. EuroCCP was established by the Depository Trust and Clearing Company specifically to service Turquoise. And while it clears for other MTFs – notably SmartPool, NYSE Arca Europe and Pipeline – Turquoise remains its biggest client based on market share.

Turquoise could also give Rolet some quick wins while he waits for the MillenniumIT acquisition to bear fruit. The LSE plans to replace its TradElect trading engine with a new trading platform based on MillenniumIT technology before the end of 2010.

“Depending on the price the LSE has to pay, acquiring Turquoise could be valuable to help tide them over and guard against further market share loss in the period until the new technology provided by Millennium IT goes live,” said Beattie.

Buy-side traders welcome the slight reduction in fragmentation the LSE’s acquisition of Turquoise would bring, but are keen that consolidation does not go too far. “Some MTF consolidation is positive in itself, mitigating some of the fragmentation, but I would prefer that, for now at least, it didn’t involve the primary exchanges,” said Brian Mitchell, head of dealing and transaction cost analysis at Baring Asset Management. “I like the improved technology it [the combination of MTF and primary exchange capabilities] would bring to the party, but I wouldn’t like to think there is an increased risk of a reversion to the old pre-MiFID un-competitive model.”