having taken on an expanded role at work, and some time consuming charitable activities of late, the old blog has been ignored, like good music at the AMAs or thoughful opinions on the cause of terrorism in American political debate. But the recent polorized debate around the IEX exchange application has been almost as annoying as the Syrian refuge “debate” on Sunday morning television. 140, 280 or 420 characters are not going to be near enough to express a thoughtful view, so i spent 20 minutes getting a new password and sit ready to spew at length. You have been warned.
First let me state for the record that i applaude much of what IEX has done. They innovated in a positive manner, even if that innovation simply involved looking at how dark markets work in Canada – where Brad, Ronan, Matt and others earned paychecks for many years – and took the easiest to borrow parts. Mid point matching, pay / pay fee schedule, broker preferencing and a mechanism to ensure against stale mid point quotes is exactly how Canada’s largest dark market has worked for years. What they didn’t borrow was Canada’s fair access rules. (For those new to this blog, I am a Canadian expat, and may at times view my home country like a long lost love…but i will try to be logically consistent).
The fair access rules force all markets, lit or dark, to have completely transparent rules, fees and operating procedures. Think the recent SEC proposal, but going further, and somehow not requiring an indefensible 584 pages to outline. Under these rules, no market is allowed to unreasonably discriminate amongst participants. This means the US style broker dark pools that only allow some dealers access, or have different undisclosed fee schedules for various brokers are not allowed. It also means that a market’s router cannot have any advantage over other routers, be they vendor, market or broker offerings. This portion of the rule was origanally enacted when the TMX Group used knowledge of hidden flows to optimize order routing, and create an unlevel playing field versus competitor routers. (This is similar to the advantage the Lava router was found to have). The rule was worded in such a way as to avoid any advantage – which would include the bypassing of a speed bump. Thus, what IEX is trying to do – and in fact what they have been doing for two years, without disclosing it to market participants – would be in violation of the Canadian rules.
So with that brief Northern history lesson in mind, lets consider what IEX is asking us to approve. There are two aspects of the application that require discussion:
1) The IEX router will not be subject to the POP when routing residual flow to away markets
2) The discretionary peg order will use quotes not subject to the POP when chosing, algorithmically, to fade the quote.
Both of these are problematic in my mind. Lets take a look at each in some detail to understand my thinking.
By allowing the IEX router to bypass their own speed bump on a route out, they create an advantage over any other router when accessing IEX flow. Let’s assume for a moment that IEX – perhaps due to the stale quote protection – continues to have strong dark market share after converting to a fully lit venue. It is likely that good liquidity seeking algos will trying to ping the IEX mid point before moving on to other sources of liquidity – perhaps other lit venues. Under the proposal such orders would be at a 350 microsecond advantage if they used the IEX router rather than any other router on the market. Why? Other than to create a marketable competitive advantage in routing capability, how does slowing down competitor routers post trade improve the quality of either IEX’s markets, or the greater market in aggregate? i have posed this question to several senior executives at IEX, and to date have not had anything close to a decent answer. If no answer exists, then how does this fit with the SEC’s long stated goal of fair competition amongst competitors? (Hey what ever happened with the 2009 equity market structure thought paper?…ah nevermind). The real problem is, if you allow this advantage every other market will instantly be incented to introduce a latency advantage for their own router…making all routers less able to compete for liquidity.
On top of this, IEX wants their discretionary peg order to be able to use non delayed data to determine when to fade the quote. Again we have a competitive issue. IEX has used fairly common quote stack logic to ensure better passive order performance. My team has been using similar strategies for years. But our current version is less effective on IEX tha their own order. Why can’t my version, using my IP have a similar latency experience, such that i am not captive to the IEX offering? And how does this play out if other markets follow suit? Exchange built algos with a latency advantage….it gets ugly quickly. Bats can introduce a pounce style algo that sees the quote quicker. NYSE can introduce a pairs algo that sees both quotes quicker. My own algos will not be able to compete. Neither will the offerings of brokers and vendors. Again, do we disagree with the long held belief that fair competition is better competition?
Now the IEX response to all of this has been along the lines of “yeah, but look at what Billy is doing”. I would send my 12 year old to his room if he pulled this garbage. Sure what Billy – or Chris, Tom and Robert – are doing is often much worse, that is not a suitable reason to approve these asymmetric mechanisms.
i started this rant by waxing poetic about the valient efforts of the Canadian regulators. Ironically, of late they have dropped the ball badly on speedbumps. They started by approving a poorly constructed mechanism of Aequitas that was aimed at aiding “natural” investors…if only those natural investors that had a Phd in Engineering and an appetite for minutiae. That lead them down the path to approving the Alpha Exchange – a speedbump mechanism designed by, and for HFT players to the detriment of natural investors. (The tweetersphere has debated this at length, with papers from Clark at ITG and Sussman at Liquidnet touted as the best explanations – DM if you need a copy of either). Canada has clearly demonstrated the destructive nature of competing latency delays. We don’t need to go there.
Now IEX, and others will argue that CHX has greater latency than they do – much like Alpha claims they are not the slowest market north of the border. But asymmetric latency is very different that symmetric latency. CHX has yet to figure out how to make their SOR skip geography.
I firmly believe every rant should end with solutions. Here are mine:
1) IEX should not make any order subject to the speedbump post trade. They all move on unencumbered. Fair to all, and the speedbump applies on the inbound order to ensure midpoint accuracy
2) If IEX wants their discretionary peg to have real time IEX quote info, then design a mechanism where all algo developers can have the same. Let’s all compete on a level playing field. You can still offer the DP, but I can write my own algo that perfomrs similar operations in a potential superior manner. Perhaps limit this to algos placing, and cancelling, passive orders.
3) The SEC should take a serious look at the Canadian fair access rules. In fact, we all should. IEX, the bastion of transparency spent the last 2 years operating their market in a manner that offered their own SOR an undisclosed advantage, and yet one could still argue they are amongst the most transparent of US dark pools. The bar is so low even Volkswagon finds it embarrassing. Let’s end the broker liquidity clubs, and preferential order types. let’s end the preferential pricing, and obfuscated matching logic. This is one of the SEC’s other tenants for fair and orderly markets – transparecny of operations…too bad it is a complete and total myth in this country.
4) Let’s end PFOF…sure not a part of the above rant, but allowing liquidity providers to buy access to flow on an aggregated basis harms the very market participants that set price. in 2015 we need to better than this
5) Let’s all stop pretending that Syrian refuges pose a greater threat to American lives, than Americans with guns. So far in 2015 we have had an incident of a child shooting, and killing an American each and every single week. Some weeks we have had more than one. If the terrorists states gave money to American politicians like the NRA does – other than Hillary Clinton – we would be ignoring this issue too….and focusing on the damage done by chemicals used to make rainbow flags or some other nonsense.
6) and finally – lets all strive for a higher level of discourse. This shouldn’t be hard. Just because somebody disagrees with you, they aren’t evil or ignorant. They have a different view. and that is ok. In some countries it is actually encouraged. They call it thoughtful dialouge, or engaged discourse. oh who the fuck am i kidding – you either agree with me 100%, or you are a Hitler loving, baby killing mother fucker who touches little boys while drinking diet Mr. Pib……yep diet Mr. Pib…and i’m not taking it back…fuck you.