Brad Katsuyama may be best known as the antagonist in Michael Lewis’ controversial book “Flash Boys: A Wall Street Revolt,” but he is an innovator. As global head of electronic sales and trading at RBC Capital Markets he didn’t like the way his customer orders were being filled. He never seemed able to hit the entire bid or lift the entire offer that the market showed when executing orders. He realized that faster players were able to see what he was up to and get in front of his orders when the order moved from one trading venue to another.
Katsuyama and his team at RBC devised smart order routing technology, Thor, which allowed an RBC order to hit different trading venues at the same time. This solved the problem in terms of RBC customers, yet Katsuyama saw the market as an uneven playing field and thought he could create a simpler and more balanced market: IEX Group, the first equity trading venue owned exclusively by a consortium of buy-side investors, including mutual funds and hedge funds. While there are those that say technology has simply allowed traders to continue the practice of finding an edge, Katsuyama feels it can be used to level the playing field among all market participants.
He cites a Nordic market study where Nasdaq sped up the matching engine by 10 times. It went from matching orders in 2.5 milliseconds to 250 microseconds. What they found was that the effective bid-ask spread of the stocks widened by 32%. Katsuyama is applying that lesson at IEX. “We’ve been trained to believe that faster speed led to narrower spreads and here you have a 10-fold increase in speed and a 32% widening of the quote,” he says. His explanation for why this happened was that in a slower market you just had high-frequency market makers. When the market got faster a new breed of high-frequency firm came into the market, which he described as bandits.
We sat down with Katsuyama to talk about market structure, colocation and what he hopes to accomplish with IEX.
Futures Magazine: Is it an advantage to be creating an exchange now when all the issues surrounding the market structure are out there?
Brad Katsuyama: Absolutely. Part of it was that the market evolved. It is hard to say if anyone intended for the markets to end up the way they did. We have the benefit of saying we know what is exactly in play; we know the types of behavior we are trying to prevent and we are trying to do that with how we operate our market by the technology we build.