Views on the integrity of global capital markets
01 December 2015

IEX Exchange Application: Is Level Playing Field Possible with Speed Bump?

Posted In: Market Structure
Speed bump on a road

IEX’s application to the US SEC to become a fully fledged stock exchange continues to make headlines in what has become an increasingly vociferous dispute among exchange operators. But behind the bluster, what are the ramifications of the SEC’s decision for investors and market integrity?

The media storm includes accusations by the NYSE that IEX is an “unfair, complex and opaque” exchange, while IEX has retorted that its features are “a response by our market to address the market complexity NYSE and other exchanges have created … [to] cater to high-speed trading strategies.”

The central feature of the IEX platform is of course its well-publicized “speed bump” that introduces a delay of 350 microseconds between order submission and execution. While that may seem trivial to casual observers, consider that most exchanges today operate with typical latencies of under 200 microseconds (and sometimes much lower). As such, the IEX delay is a significant differentiating feature and mitigates so-called “latency arbitrage” trading strategies in which fast or high-frequency traders (HFTs) profit from trading against stale quotations. Buy-side traders and institutional investors often complain that these trading strategies are unfair or increase transaction costs.

If the aforementioned speed bump is a solution to these concerns, investors will vote with their feet and trade volumes will migrate accordingly. Indeed, IEX’s market share has grown from approximately 0.1% from its launch in October 2013 to approximately 1.64% in October 2015.

However, IEX currently operates as an ATS (Alternative Trading System), meaning that, among other things, it does not have to display the prices and sizes of orders (pre-trade transparency) prior to execution and may restrict access to its system. To become a registered stock exchange, IEX will have to display its prices in the consolidated quotation data and provide for fair and open access.

The principles of transparent, nondiscretionary, and nondiscriminatory trade execution provide the necessary conditions for a level playing field between exchange venues, and it is these principles that should matter most in the ultimate consideration of IEX as an exchange. Provided that these conditions are satisfied, the speed bump or any other differentiating features should be somewhat irrelevant.

The most common trading model currently operated by exchanges is the continuous-auction model (which provides continuous, real-time trade execution as opposed to, say, trading in fixed time intervals). In a continuous auction, trading is based on price-time priority rules (i.e., the highest-priced bids and lowest-priced offers are first in the order queue, while same-priced orders are prioritised according to the time of submission into the order book). This model rewards speed: the fastest traders can best manage their limit orders to be at the top of the order queue or avoid being picked off when prices move in real time (an issue known as adverse selection, also covered in a CFA Institute report).

Yet the continuous auction is not the sole operating model deployed by exchanges; indeed, the NYSE itself operates an opening and closing call auction mechanism to establish a clearing price for stocks (i.e., an equilibrium price that maximises the tradable quantity), while others have touted the benefits of periodic batch auctions (allowing trading to occur only at discrete time intervals) throughout the day.

Moreover, the concept of slowing down trading is not necessarily new or unique to the IEX platform. For example, and in a related context, Professor Larry Harris, CFA, writing in the Financial Analysts Journal, argues that a small, randomized delay can help to eliminate the costly HFT arms race, whilst still allowing markets and investors to benefit from the sharp reductions in trading costs electronic markets and automated trading strategies have brought.

In short, plenty recognize that speed-based trading is not always, and everywhere, the most effective market model. The challenge facing IEX is simply for investors and regulators to accept a continuous auction, fixed-delay market model and for it to fit comfortably within the market structure ecosystem so that investors can trade fairly and seamlessly across exchange platforms.

Ultimately, innovation in market design and diversity of business models that cater to different investor needs must be beneficial. Regulators should not favour one business model over another; it should be the job of the market to decide which model works best and satisfies investors’ needs. Provided all venues operate according to the same principles of transparency and fairness, venue competition should ensure efficient outcomes for investors.


If you liked this post, consider subscribing to Market Integrity Insights.


Image credit: iStockphoto.com/TomasSkopal

About the Author(s)
Rhodri Preece, CFA

Rhodri Preece, CFA, is head of capital markets policy for the Europe, Middle East, and Africa (EMEA) region at CFA Institute. He is responsible for development and oversight of capital markets activities in the EMEA region, including content development, policy engagement and outreach. Rhodri formerly served as director of capital markets policy, focusing on issues related to primary and secondary market structures. He was named one of the “40 Under 40 Rising Stars of Trading and Technology” by Financial News.

Leave a Reply

Your email address will not be published. Required fields are marked *



By continuing to use the site, you agree to the use of cookies. more information

The cookie settings on this website are set to "allow cookies" to give you the best browsing experience possible. If you continue to use this website without changing your cookie settings or you click "Accept" below then you are consenting to this.

Close