I suspect Im not the only industry participant whos suffering from IEX fatigue. After months of debate and media attention, Ill bet there are many who let out a collective groan when they read that the Securities Exchange Commission is asking for more time to review IEXs application to become a stock exchange. But even with more months of analysis and explanation in front of us, its clear that the SEC has made the right move.
The longer this application process has gone on, the more IEX has had to clarify, as evidenced by its multiple letters to the SEC responding to industry concerns and recent 300+ page amendment to their original application. With the SEC going to the added step of formal proceedings to grant or deny the IEX application, it moves from a letter-writing phase focused on philosophical support or opposition, to a fact-finding inquiry on how IEX would impact our National Market System. Such a transition cant happen soon enough.
It is time to find data-driven answers for the real questions this application raises: What is the effect of a delayed, protected quote on the NBBO? What are the consequences of a stale NBBO? What effect will it have on best execution and its reporting to investors? What is the effect of exchanges allowed to adjust, in real time, dark exchange liquidity (pegged orders) that are interacting with orders intentionally delayed? And, quite simply, how will the introduction of intentionally delayed protected quotes complicate market structure for investors?
If complexity is synonymous with more exchanges, that last question has already been answered. BATS was the first to give a glimpse into its plans, stating in its comment letter last fall that it was incumbent on the Commission to articulate in its approval order the permissible standards for intentional delays. That is the market structure equivalent of Babe Ruth calling his shot. Clearly, if delayed protected quotes become the law of the land, expect a BATS exchange application, or two, seeking the same for its members.
In the more immediate term, Nasdaqs recent acquisition of the International Securities Exchange (ISE) gives it licenses that could be used to run more equity-trading venues. So unlike BATS, which would likely opt to file for additional licenses rather than convert any of its current exchanges, Nasdaq would need only to activate some ISE licenses and file rule changes to quickly begin intentionally delaying quotes as well.
Not to be outdone, NYSE filed a rule change reminiscent of IEXs controversial, albeit yet unapproved, pegged order functionality. This lets an exchange take an active role in assessing market conditions to make pricing decisions for its members pegged orders – an action that is usually the responsibility of the broker-dealer. As it stands in its application, IEX can offer an advantage to pegged orders with real-time market data interacting against contra flow that has to swirl around its shoebox delay while lugging a stale quote around.
So with all of that coming to a head, I think it is wise for the SEC to step in and engage the industry in a dialogue about the potential consequences of granting IEXs unorthodox functionality exchange status. For an application with this much noise around it and this much at stake, I believe this is the sober path forward for all market structure participants.
Bill Harts is chief executive of Modern Markets Initiative, an HFT advocacy firm that was founded by a group of high-frequency trading firms.