There has been mixed reaction to the news that a consortium of major International Investment Banks is to build a new exchange, or, to be precise, a Multi-lateral Trading Facility (MTF)—“the project Turquoise”—to challenge the dominance of the predominantly national stock exchanges in trading of cash equities, though it should be noted that MTFs may trade any financial instruments and are not restricted to the trading of cash equities. The MTF will be operated on a mutual not-for-profit basis and access will be available to other financial intermediaries and investors: banks, brokers and fund managers. European exchanges have, anecdotally, reacted with apprehension and there has been some downward movement in the share prices of publicly listed exchanges.

Some commentators suggest that the underlying motives of the consortium are to pressurise the exchanges into reducing their fees and revising their overall cost structures, directly or through consolidation with other exchanges, before they reach the point of substantial investment in the MTF venture. Others are highly sceptical about the cultural aspects of the consortium's proposition: delivery and management of a not-for profit exchange by some highly egotistical organisations. Such varied comments as “piranhas have to feed” and “would this MTF endure a lengthy period of dull or weak cash equities markets?” reflect the scepticism.

Aside from these comments the consortium does face a number of technology challenges if, as reported, it is to deliver the MTF for November 2007, when MiFID is due to become operational. It should be stressed that there is no regulatory imperative for the MTF to be delivered by this date. Perhaps, it is aspirational at this stage, motivated by ego?

By way of background:

• MTFs are alternative venues for trading financial instruments, referred to in the UK as Alternative Trading Systems (ATS).
• MiFID establishes and sets authorisation requirements for MTFs, which can be operated by investment firms or market operators, such as Regulated Markets (Stock Exchanges). It formalises to a great extent the regulatory regime, which already exists, for example in the UK, under the FSA regulatory regime for Alternative Trading Systems.
• MiFID permits both investment firms and operators of RMs to operate MTFs (currently systems operated by RMs are not classified as MTFs/ATS.) RMs operating MTFs will have to comply with MTF requirements.
• MTF operators will be able to make their facilities available to users across the EU on the basis of their home country authorisation.

Each national financial regulator will have to establish specific rules and regulations for MTFs. The UK Financial regulator published a consultation paper outlining the rules under which it would propose to operate a regime for MTFs for which it becomes the home regulator. It would be surprising if other EU national financial regulators, who have yet to publish proposed detailed rules, propose any rules which have substantive differences, unless they are seeking to discourage the establishment of MTFs by more restrictive regulations or to encourage regulatory arbitrage by “a lighter regulatory touch over their MTF regime.” The FSA sets out the major business and environmental issues in which the technology will have to accommodate:

• The FSA intends to implement the MiFID requirements by setting uniform requirements for all MTFs except in respect of transparency rules. However, it does intend to retain tailored permission variations of “permissions for those MTFs that operate a primary market in shares to clarify how they would expect MTF operators to satisfy some of the MiFID requirements.”
• The FSA will continue the transparency regime it already has in place for ATS operators for MTFs including publishing of pre- and post-trade information for financial instruments traded on RMs as well as for instruments not traded on RMs. The FSA views transparency requirement as “a necessary element of appropriate arrangements for fair and orderly trading and expects MTFs to maintain them under MiFID.”
• MTFs will be required to establish transparent rules governing access to their facilities and the financial instruments that can be traded on those facilities. MTFs will have to comply immediately with any instructions from the FSA to suspend or remove a financial instrument from trading.
• MTF operators must have in place the necessary arrangements to facilitate the settlement of trades transacted through their system and ensure users understand their own responsibilities for settlement.
• While MTF operators may make arrangements with Central Counterparties (CCPs), Clearing Houses and Settlement Systems from other Member States but the FSA “may prevent MTFs from entering such arrangements where necessary to maintain the orderly functioning of the market and taking into account the conditions for settlement systems established by the Directive.”
• Pre-trade transparency obligations will require MTFs to ensure that business is conducted on a fair and orderly basis for all asset classes, and provide sufficient information about quotes and orders to users, though waivers are permitted for some market models, but there are more extensive requirements for shares admitted to trading on a RM.
• The FSA intends to use its powers to grant pre-trade transparency waivers for:
• • crossing systems which meet MiFID conditions.
  • systems which formalise negotiated transactions and meet MiFID conditions.
  • order management systems operated by MTFs that meet MiFID conditions, and/or
  • transactions which are large in scale.
• The FSA considers there is sufficient post trade transparency in the markets of a UK ATS operator when determining whether the business conducted by means of its facilities is carried out in a fair and orderly manner. MiFID imposes more rigid and detailed requirements for post-trade transparency for MTFs, which operate markets in shares traded on a RM. Arrangements to make pre- and post-trade information public must meet certain conditions.
• In respect of capital requirements any firm operating a MTF will be subject to the recast EU Capital Requirements Directive (CRD) from 1/11/07 but may be subject to the CRD before that (1/1/07) on the basis of its other activities, specifically where they carried out other investment services. However, if they were service companies operating ATSs (which are not eligible activities and were outside the scope of CRD) this will not come into operation until 1/11/07.
• Firms operating MTFs in addition to other investment services will have to meet higher requirements post MiFID.
• The FSA estimates the minimum capital requirement for operating a MTF under the MiFID will be EU 750k. MTFs will be subject to capital resource requirements, which take into account risk profile of the business and the cost associated with undertaking their investment activities but MTF operators operating “a limited licence firm” may have lighter requirements.

The key questions for the technology delivery and operation are:

• The Technology attributes will be increasingly important for differentiating the RM and competing with Exchanges and other RMs from a cost and operating efficiency perspective.
• Technology is capital intensive. As part of the continual demands for improved speed and transparency of transaction execution, IT investment will be a continual and substantial investment requirement. Exchanges and, doubtless, RMs, will be assessed and rated from a credit rating perspective on their management of IT investment from risk management, financial and operating efficiency criteria.
• Becoming a RM is a strategic step—one for the longer term. Members of the consortium have a historic reputation of exiting markets, which turn commercially adverse. Such behaviour would affect reputation in an enterprise with a mutual not-for-profit culture, where surplus revenues are reinvested to reduce the costs of transaction fees for members and where they members would have to fund the deficits at least until a point at which exit or termination was mutually agreed.
• To deliver this project the consortium will have to buy the technology from a third party—most likely another exchange or existing ATS. Those with suitable technology for sale/licence may be somewhat resistant if they see the project Turquoise as a threat to their own business.
• The technology will require versatility, enabling connection to facilitate the settlement of trades transacted through their system and ensure users understand their own responsibilities for settlement of transactions. Equally project Turquoise will be obliged to make arrangements with CCPs, Clearing Houses and Settlement Systems from other Member States.
• The governance of the RM will have to be independent. The consortium must not influence operational and technology issues in a way which promotes the individual members of the consortium. Conflict of interest must be as rigidly managed in this element of the business as much as in the trading and execution of transactions.

At present the challenges to deliver the MTF by November 2007 seem overwhelming. As project Turquoise unfolds over the next year it will be interesting to revisit some of these issues in more detail to evaluate how the consortium addresses them.