having read all the various comment letters on IEX, i am thrilled to see such an engaged debate on the public stage. The two Citadel letters, while laughable self serving, have made for excellent reading. That said, i believe the special POP exemt status given to the IEXS router poises a couple of issues that have yet to be flushed out…so microsoft surface in hand, and sitting on the O’Hare tarmac, i will try to share some insights.
I feel it is important when debating the issue, that we remove the emotion around IEX from the discussion. if approved we can reasonably assume other markets will copy the latency advantage for their own routers, so lets consider a generic router that subjects other routers and its own direct feeds to a speed bump of a few hundred micro seconds, but exempts its own router.
What happens when market X is the unique best bid or offer on a stock. Let’s take stock XYZ which is quoted at 10.00 – 10.01 at Generic Exchange (GEX), but the best away visible offer is 10.03. A size buyer at 10.02 can use the GEX router to buy stock at 10.01,getting near certainty of price, before routing out to other dark markets. Those markets, using direct feeds from GEX, will not be aware of the quote change – due to the speedbump – when the resid arrives at their market. As such, they will price mid point fills at 10.005 rather than 10.015….that is, the passive order is being arbed – in exactly the manner Michael Lewis highlights in Flash Boys – because of the speed bump.
it gets worse. HFT firms will be incented to place Canary orders on GEX, using the GEX router, to get a small fill and thus quote information hundreds of microseconds ahead of the rest of the market. The 10.01 offer in the previous example – possibly for 100 shares, or even an oddlot – will result in the HFT knowing of a buyer and being able to latency arb other dark markets. As HFTs become aware of dark orders in quasi liquid names, in various dark market, they can use such canary orders to lift such orders are advantageous times. The informational asymmetry creates latency arbitrage opportunities on away markets. Thus such a feature on GEX would allow for latency arbitrage on IEX, as long as their speedbump was longer than the IEX speedbump. So each market is incented to have slightly longer delays.
The speedbump at IEX makes sense when it is a purely dark market. But when it becomes a lit venue, and the speedbump is not applied universally, it is a rabbit hole not worth traversing. Were it not for the born in a manger reputation of Brad and his wise men, the whole street would be up in arms. Sadly, a firm that started in the right direction – even if answers they personally gave me about their SOR and POP, two years ago, have proven to be misleading – is now moving in a direction that is commercially driven and harmful to markets. the exact thing they rightfully claimed Citadel, BATS, NYSE and all the broker dark pools have been doing for years.
For those of you defending the SOR treatment, please explain how my examples are either wrong or non problematic.
About to take off, have to run