Group Co.
The Emperor's New Clothes
Traders Magazine Online News, June 20, 2017
This is Part One of Two:
The one year anniversary of the approval of the ironically named "Investors Exchange" has triggered more media coverage and I feel like the little boy the classic Hans Christian Andersen story: “The Emperor’s New Clothes.” Sadly, like the "clothes" worn by the emperor, the marketing claims made by IEX are similarly transparent. Equally sadly, others see it, but like the ministers and townspeople in the story, won’t say so for fear of provoking the ire of the emperor and their supporters.
The key is to evaluate IEX as an exchange, however, I must clarify what an exchange is first, so consider the following definition from Investopedia:
An exchange is a marketplace in which securities, commodities, derivatives and other financial instruments are traded. The core function of an exchange is to ensure fair and orderly trading, as well as efficient dissemination of price information for any securities trading on that exchange.
This emphasized the primacy of displayed prices for exchanges as did the SEC, when they adopted Regulation NMS:
“limit orders are the building blocks of public price discovery and efficient markets. They (commenters) stated that a uniform rule for all NMS stocks, by enhancing protection of displayed prices, would encourage greater use of limit orders and contribute to increased market liquidity and depth. The Commission agrees that strengthened protection of displayed limit orders would help reward market participants for displaying their trading interest and thereby promote fairer and more vigorous competition among orders seeking to supply liquidity.”[1]
Therefore, for this commentary, we will examine IEX’s marketing claims, based on how their claims apply to displayed limit orders and trades which interact with such orders. On their website, IEX claims to be a “Fair, Simple, Transparent Exchange”. We will start with “Fair”
"Fair" – The most appropriate definition of “fair” is free from bias[2], meaning that IEX is asserting that at their exchange, no class of investor has an advantage over other classes due to their architecture. They cite two features to back up this assertion: First, they do not offer co-location services, which they claim provides advantages to HF firms, and second their speedbump “slows down the market” which helps their clients vis a vis HF traders. Let’s look at each in turn:
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