(Editor’s note: This article was written before IEX receoved approval to establish a stock exchange.)
A year and a half ago, IEX Group gained national attention as the hero of the controversial Michael Lewis best seller Flash Boys. Now, as the firm seeks to transition its stock trading marketplace into a full-fledged stock exchange, controversy still seems to be following it.
The issue that is stirring up noise is the same one that made it famous-its Point of Presence (POP), also known as the 350-microsecond speed bump that IEX employs to neutralize the speed advantage that high-frequency trades have over their slower counterparts.
The battle lines have been interesting. High-frequency trading firm Virtu joined other firms including The Capital Group, Oppenheimer Funds and Themis Trading in support of IEX.
Southeastern Asset Management submitted a supportive letter that contained signatures from 14 other investment management firms.
On the other side, in addition to the other more established exchanges (Nasdaq, the New York Stock Exchange and BATS Global Markets), critics of the IEX application have included Citadel LLC, the high-frequency trading advocacy group Modern Markets Initiative, and FIA Principal Traders Group, an association of more than 25 prop traders.
Citadel argues that IEXs speed bump violates Reg NMS. Language in Reg NMS specifically states that exchanges cant use any type of intentional device that would delay the action taken with respect to a quotation.
IEX argues that its speed bump, which is essentially extra lengths of coiled cable through which bids and quotes must travel, is a form of physical distance, and argues that unintentional lag times due to physical distance and technology already exist in the current markets. It also says customers report that the delays in execution at IEX are comparable to delays at the other exchange venues.
This design is not dissimilar to the coiled cable provided by the NYSE, Nasdaq and BATS families of exchanges in their respective data centers. Those exchanges, however, coil cable within their data centers specifically to create equivalent distance for participants who have paid for the privilege of colocation, whereas IEX coils a longer length of cable in an attempt to create fairness for all participants, IEX wrote.
The back-and-forth arguments may give the SEC several big-picture issues to think about.
I think that this exchange application is a big Pandoras box for the SEC. The SEC is forced to look at several activities and practices in the market because they are all wrapped up in this IEX flag, said Sal Arnuk, partner, co-founder and co-head of equity trading at Themis Trading. One of them is the Reg NMS one-second look-back exemption. How appropriate is that in this day and age? Another is this whole practice of colocation.
Reg NMSs one-second look-back exemption, which has been credited with creating large volumes of sub-second latency arbitrage, is the one of the key issues that IEX set out to address with its speed bump.
Over the past several years, the SEC has allowed colocation, where trading firms locate their servers in the same data center as exchanges for fast access, to flourish. Colocation supporters argue that everyone has the opportunity to buy it.
But IEX supporters argue that by that argument, everyone could have the opportunity to choose IEXs speed bump as well.
Everyone has the opportunity to go as fast as they want, Arnuk said. Its a competitive decision. The market will decide. Its funny how those very same people will quickly change their tune if someone wants to innovate and swing the pendulum the other way.
