On Friday, June 17, the Securities and Exchange Commission approved the promotion of IEX from an ATS to a proper exchange. Thereby it gave a new ending of sorts to Michael Lewis’ book, Flash Boys.
One of the big issues for both proponents and opponents of IEX’ application to become an exchange was the system’s “coil delay”, the key innovation designed to help counter latency arbitrage. A message sent to the IEX trading system in Weehawken, NJ goes first to Secaucus, where it must pass through a box of (as the SEC explains) “compactly coiled optical fiber cable,” before moving on to Weehawken. The length of the coil along with the distance between the two New Jersey locations represents an equivalent of 350 microseconds of latency. Trading, thus, is deliberately slowed for both incoming and outgoing messages.
In the words of the IEX itself, the setup “ensures that no market participants can take action on IEX in reaction to changes in market prices before IEX is aware of the same price changes on behalf of all IEX members.”
The SEC now finds that this design does not unfairly discriminate to the detriment of either investors or the public interest. One important consideration with these deliberations has been that the same coil delay applies to all IEX users equally, and may not be bypassed “for a fee or otherwise.”
Another consideration: IEX’s own direct proprietary market feed, an optional data feed that may be made available to subscribers, will itself have to traverse the coil.
On the same day the application was granted, the SEC released a new interpretation of Reg NMS that makes it clear that the word “immediate” in that rule does not have the meaning that the adversaries of exchange status for IEX wanted to give it, that it allows for a de minimis intentional delay, defined as “a delay so short as to not frustrate the purposes of Rule 611 by impairing fair and efficient access to an exchange’s quotations.”
If one tries to follow that interpretation, one is led down a rabbit hole where clause X uses terms defined in clause Y, which uses terms defined in clause Z, and so forth.
But less recursive explanations come from the portion of the interpretation that responds to comments the SEC has received on this issue. For example, the SEC quotes economist Charles M. Jones, the director of the program for Financial Studies at Columbia Business School., and a member of the economic advisory board of FINRA. Jones wrote, “From an economic point of view, the 350-microsecond delay per se should not be a particular cause for concern, as it is well within the bounds of the existing geographically dispersed National Market System, and does not seem likely to contribute substantially to a phantom liquidity problem.”
Likewise, the SEC quoted David Lauer, of the Healthy Markets Association, a “coalition led by independent experts in market structure analysis and research.” Lauer said that the national best bid and offer system “already includes quotes with varied degrees of time lag” whether IEX becomes an exchange or not, and that the consequences of IEX’s notorious coiled cable will be far less than that of the “distance between NY and Chicago, and … remarkably similar to the distance between Carteret and Mahwah (36 miles)”.
Promoting Competition and Innovation
In a press release, making reference both to the approval of IEX as a national exchange and to the accompanying interpretation of Reg NMS, Mary jo White, the SEC chair, says that these actions “promote competition and innovation, which our equity markets depend on to continue to deliver robust efficient service to both retail and institutional investors.”
By the way, the IEX order was 122 pages long. But here is the key bit:
“Further, the Commission finds that the proposed rules of IEX Exchange are consistent with Section 6 of the [Securities Exchange] Act of 1934 in that, among other things, they are designed to: (1) assure fair representation of the exchange’s members in the selection of its directors and administration of its affairs and provide that, among other things, one or more directors shall be representative of investors and not be associated with the exchange, or with a broker or dealer; (2) prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, and remove impediments to and perfect the mechanisms of a free and open market and a national market system; (3) not permit unfair discrimination between customers, issuers, or dealers; and (4) protect investors and the public interest.”