Will upstart IEX gain SEC approval?

May 21, 2016 09:00 AM

Alternative Trading System IEX burst on the scene after Michael Lewis’ 2013 bestselling book “Flash Boys: A Wall Street Revolt” turned its founder, Brad Katsuyama, into the fair-haired protagonist fighting the evils of Wall Street. 

The book was not only a best seller, but a pretty strong marketing tool for a new venture. And IEX built volume quickly. When we spoke to CEO Brad Katsuyama last fall after IEX applied to become a full-fledged stock exchange, he estimated IEX’s total market share at 2% and stated that its volume grew 100% year-over-year. 

At that point the comment period of IEX was well under way and Katsuyama pointed out that there were not many surprises: “When you look at who has responded 
positively and who has responded negatively, it is exactly who we thought,” he said. 

The IEX exchange application has created some controversy and is nearing the 9th inning. IEX has amended its application four times in response to some of its critics. 

As Katsuyama pointed out, many of the comments are predictable. Most of the broker dealer world are highly supportive of IEX, while competing exchanges and some industry groups are highly skeptical.


IEX, thanks arguably to Lewis’ book, is still seen as the answer to an unfair market structure weighted against the retail trader. 

The following note from Rebecca Cole is typical:
The IEX would provide an option for those who want a fair and level playing field for stock exchanges. As one who will be relying on 401K s for retirement I would appreciate a straight forward honest option, the IEX. I would hope the SEC would approve this application and be an advocate for transparency and honesty in efforts to restore our faith in the financial markets.”

Lewis’ fingerprints are seen in the following comment from Alex Sarly: 
Having been introduced to IEX through Michael Lewis’ writing I am a supporter of what IEX stands for and would like to see their application approved by the SEC as soon as possible.”

Such retail passion has not escaped the interest of politicians as this following comment from Congressman Brad Sherman (D-CA) shows:
If there is an exchange that believes they have technology that can curtail high frequency trading, restore market integrity, and protect investors, it should be given due consideration by the Commission. Real investors should be able to select an exchange where they are not preyed upon by high frequency traders.”

Much of the support from retail investors hit on many of the themes IEX corporate supporters mentioned and appeared unique, not reposted form letters, such as submitted by Suzanne Shatto: 
“They don’t pay rebates, they have slowed down access so that speed is not as advantageous as it is in other exchanges, they have few order types (and) they do not offer services to privileged clients.” 

IEX has garnered a great deal of support from the broker dear community as the following comments show:

Southeastern Asset Management (Investment advisor)
IEX’s is a market-based solution that will help evolve the competitive landscape to consider investors’ interests while addressing many industry concerns: Conflict-free pricing, simple order types, safe technology, equal access [and]transparency.”

Cowen Group (broker dealer) 
Cowen has been routing orders to IEX on behalf of customers since its Oct. 25, 2013, [launch as an ATS]. During this time period, there have been a handful of technology failures at REG NMS exchanges and regulatory infractions at various ATS’, highlighting the need for both reliable technology and good actors in leadership positions at the epicenter of the execution ecosystem. Our experience with IEX has been highlighted by fair, transparent, market-based solutions which simplify structural complexities in the marketplace.”

Themis Trading (institutional brokerage)
IEX is different. They don’t use maker taker pricing. They don’t sell colocation or data feeds. They employ technology designed to even playing fields, rather than exploit information asymmetry. Their offering is a stark alternative to other stock exchange models that seem to be more focused on selling speed and data. We were among the first brokerage firms to transact on IEX and we continue to transact there today. We are pleased to voice our support for IEX’s exchange application. Additionally, their transparency with regard to their operation is not only refreshing, it has inspired a wave of transparency among numerous other ATS’s that have chosen to follow its example. IEX has impacted market quality in a most positive way.

Opennheimer Funds 
In its 2010 Concept Release on Equity Market Structure, the SEC noted its task has been to facilitate an appropriately balanced market structure that promotes competition among markets, while minimizing the potentially adverse effects of fragmentation on efficiency, price transparency, best execution of investor orders, and order interaction. IEX is a market-based solution designed to address several of these issues. It was the first alternative trading system to voluntarily publish its SEC Form ATS which effectively made IEX a transparent dark pool. Several alternative trading systems followed suit.

A group of investment managers who identified themselves as signatories to the U.N.-supported 
principles for responsible investment

Approving IEX’s application will provide long-term investors and their agents with a genuine alternative in the exchange landscape: one that does not pay execution rebates, does not offer an array of complex order types, and does not emphasize speed and opportunities for structural arbitrageurs. … This application is not a referendum on high-frequency trading or on any specific market structure issue. Rather, it is about whether investors have the right to choose alternatives and whether IEX will be granted the right to compete. The current competitive landscape amongst exchanges is characterized by an undue focus on latency reduction and catering towards the needs of a high-paying sub-class of market participants. This has been to the detriment of long-term investors, whom markets are meant to serve and the Commission is tasked to protect.”

Many competitors are demanding changes that go to the core of IEX’s unique value proposition, and has forced some changes in the application. But the main question is whether the so-called 350-microsecond speed bump would result in stale order being routed to the Reg NMS NBBO system. 

IEX should be granted registration as a national securities exchange. In doing so, it is incumbent on the Commission to articulate clear standards regarding the amount of intentional delay a registered exchange can implement to accessing its quotation that would allow such quotation to be consider automated under Regulation NMS. BATS further believes that as currently configured, IEX is providing an unfair and unreasonably discriminatory advantage to its affiliated broker-dealer in the form of real-time transaction reports from its private market data feed that is delayed to the rest of the industry,  that may be acceptable while IEX is an ATS, it must be remediated as a condition to granting IEX’s Form 1 application (This was removed). 

PDQ Enterprises (ATS) 
We disagree that implementing some of IEX’s features in an exchange environment would benefit the markets as a whole. In fact, as other industry commenters have noted, granting the delayed quotes at IEX protected status has the potential to cloud price discovery and impede market efficiency to a great degree. As we understand Regulation NMS, if approved as an exchange, IEX bids and offers would benefit from quote protection. However, PDQ argues that because of the delay imposed by the IEX speed bump, its quotes may not be truly actionable on an alarmingly regular basis. Assume a stock order — directed to exchanges by high-speed smart order routing computers — recognized the best price at IEX. Since that price has already traveled through the speed bump, it is 350 microseconds old. However, by current NMS rule, the new order must be routed to that best price, where it is also subject to the 350 microsecond speed bump. Compared to other exchanges, then, the quotes visible on IEX would be 700 microseconds behind.

Comments from supporters and competitors can be predictable, the following commenters don’t appear to have skin in the game. 

Futures Industry Association Principal Traders Group
IEX’s intentional access delay still does not comply with Rule 611 of Regulation NMS, and as such, these purposely delayed quotes should not be protected. In addition, as described in our previous letter, IEX should not be permitted to give hidden pegged orders a speed advantage over other order types, including displayed quotations. FIA PTG respectfully urges the Commission not to approve the IEX application until IEX resolves these two remaining concerns.

Virtu CEO Doug Cifu 
Virtu joined IEX’s automated trading system as a founding member at its inception and has been among its top liquidity providers by volume ever since. Virtu engages in precisely the same market making strategies on IEX as we do on automated 2 trading systems run by other broker-dealers, such as Barclays LX and JPM-X, as well as on registered stock exchanges, including the New York Stock Exchange and Nasdaq. IEX’s “speed bump” has had no impact on Virtu’s market making and liquidity provisioning on the platform.

AK Financial Engineering Consultants
An intentional delay is not in compliance with Reg NMS. So despite Michael Lewis and some retail traders imagining some huge HFT conspiracy, the only ones truly impacted by rejection of the application are buy side traders, some of whom are IEX investors, moving institutional size trades. But if those institutional traders are so happy with the IEX ATS, let them continue to trade on IEX as an ATS or as a hybrid, without forcing and disadvantaging other traders from routing there with the deliberate delay. The deliberate delay disadvantages many other institutional traders, including, but not limited to, arbitrage traders who keep disparate markets and disparate assets in sync.

Patrick L. Young, CEO of DV Advisors and Publisher of newsletter “Exchange Invest”
The IEX, born of fresh, innovative thinking delivers a fascinating new approach to the market structure which is positive for investors [and] good for markets as a whole...The IEX model is complimentary to the existing structure in US markets, delivering an element of unique customer choice backed by strong management and an already diverse user base.”

To view all comments on the IEX application, visit sec.gov.

About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.