Weeden Suggests Half-a-Loaf for IEX

Weeden Suggests Half-a-Loaf for IEX

As regular readers know, AllAboutAlpha has been following the continuing controversy over IEX, the ATS designed by Brad Katsuyama around a “speed bump.” For the uninitiated, that speed bump is a trick for saving institutional investors from the rigors of an otherwise-necessary arms race with the high-frequency traders.

Of late, the controversy over IEX has focused on the question of what the Securities and Exchange Commission should do about its application for exchange status.

Should IEX become an exchange or not?

Critics have suggested that IEX’s system was designed in such a way that, were it to become an exchange, it would have an unfair advantages over the other exchanges because the IEX Router would not itself have to go over the speed bump to access the matching engine.

Pursuant to its application to the SEC for exchange status, in response to these critics, the IEX has proposed one important change in its own modus operandi; it will adjust its order-handling procedures for routable orders.  Specifically, IEX says that once a routable order has made its way over the speed bump, it will go directly to the router, not to the matching engine. From there, the router will divide this parent order into optimal parts, and send those child orders to a mix of the 13 available exchanges.

“The Router will interact with the IEX matching system over a 350 microsecond speed-bump in the same way an independent third party broker would be subject to a speed bump,” IEX wrote in its February 29 filing with the SEC.

Meanwhile, though, IEX as an exchange would work much the way IEX as a dark pool works. In a recent analysis by Weeden & Co., this is described thus: working with “a pool of hidden peg orders that it re-prices using the other exchanges’ proprietary data feeds,” which is friendlier to liquidity providers than to liquidity takers.

Thanks for the Concession, But…

Despite the concession, the IEX application continues to generate controversy.  Looking at the comments posted subsequent to February 29, one doesn’t find any earlier critics saying, “Oh, okay, never mind then.” More typical is the response of Joan C. Conley, Senior Vice President of Nasdaq, who wrote, “Nasdaq applauds IEX’s reversal [on order-handling procedures], but consequential deficiencies remain.”

Weeden & Co., in the analysis quoted above, proposes yet another compromise.  Its analysis begins with the observation that the speed bump “is a clever innovation that protects hidden liquidity providers from trading at stale process.”   Yes, in a sense this requires action at the expense of liquidity takers, but the benefit accrues to the system as a whole. The only liquidity takers who are hurt, Weeden says, are traders who attempt to take liquidity “just before or just after the [National Best Bid or Offer] moves in their favor.”  Traders seeking liquidity at any other moment will gain value.

“As most retail brokers and wholesalers can attest, this is the beauty of segmentation: when it’s done well, value accrues to both sides of the trade.”

But Weeden sees a problem. Specifically, it is concerned that granting IEX’s quotes the trade-through protection that generally comes with exchange status could prevent the National Market System from becoming more efficient over time.  Other exchanges could simply imitate the deliberate latency feature, latency will proliferate, and the historical trend toward greater efficiency in price discovery will come to a screeching halt.





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