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The Emperors New Clothes, part 2
Traders Magazine Online News, June 27, 2017
The first part of “The Emperor’s New Clothes” pointed out the fallacies of IEX’s core claims of being “Fair” and “Transparent”. I
n part 2, I will explain several serious issues with IEX’s recent paper[1] that they published to demonstrate the execution quality of their exchange. Despite the use of LaTeX software and publishing the paper on SSRN, the paper combines legitimate statistical analysis with unsubstantiated marketing claims. Yet, like most of the rhetoric that emanates from the Investors Exchange, the conclusions seem to get accepted at face value, despite the marketing content.
The perspective of this analysis, like my previous note, is on IEX’s value as exchange. Therefore, for this commentary, we will examine IEX’s paper, based on how their statistical analysis applies to displayed limit orders and trades which interact with such orders.
The paper, written by IEX, produced data on block size, midpoint volume, hidden volume, queue size, trade markouts, price improvement, price discovery, and market stability. Of those, the only statistics that exclusively focus on displayed orders are queue size and price discovery. My contention is that the analysis on block size, midpoint volume, hidden volume and price improvement should be re-done to compare the dark component to other dark pools and to separate out the displayed component for comparison to the other exchanges. This is particularly vital with regard to price improvement, as I discussed in part 1 of this series, due to the regrettable decision of IEX to conflate both non-marketable and marketable flow together.
Price Improvement
My analysis, which is exclusive to marketable orders, analyzed price improvement via the use of public 605 data filed by IEX and other market centers. This data shows, unlike the conclusion reached in the IEX paper, that, while good, IEX’s execution quality for marketable limit orders was inferior to most of the other exchanges. According to public 605 data aggregated by BestXStats, IEX’s April EQ, for all marketable orders, was 97.4, while Bats was 93, NYSE ARCA was 92.5 and Nasdaq was 91.3. I also showed that IEX was significantly inferior, on the same basis, to the largest dark pool (UBSA, whose EQ was 71.6) and concluded that overall execution quality of IEX is good, but not what they claimed. The difference between this data and what was shown in the paper, is that the paper was based on trades, without regard to the type of orders that created them. That was truly an unfortunate choice, and is an excellent example of why exchanges should not “grade their own homework.”
Rule 605 categorizes trades for market center execution quality as “marketable or non-marketable”, and, I believe this segregation was done for a good reason. Marketable orders, including both marketable limit and market orders are executable, at least in part, at the NBBO. Non-Marketable orders, including inside the quote, at the quote, and outside the quote orders, however, are not immediately executable and, therefore, have much lower fill rates on average. My contention is that the more proper analysis is to only look at marketable orders, for two reasons:
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