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 IEX, described in author Michael Lewis' book "Flash Boys: A Wall
Street Revolt" earlier this year as a place for investors to place
buy and sell orders without worrying that they are being "front-run"
by other traders whose order transmission speeds are faster than
theirs.
IEX has put in place a "speed bump" – delaying incoming orders by
350 millionths of a second, or a thousandth of the time it takes to
blink -- on its trading venue, letting it update prices faster than
the fastest market participants can calculate them, so that
high-frequency trading firms cannot use their speed advantage to
front-run others.
The strategy has proved popular with investors, who have made IEX
the 7th most used alternative trading system in the U.S. for the
week of July 7, according to data from the Financial Industry
Regulatory Authority. However, instituting any sort of trading delay
clashes with current market rules for exchanges, which is eventually
what IEX has said it wants to be.
The U.S. Securities and Exchange Commission may decide to revisit
the rules, keeping with its stated goal of protecting investors,
while allowing IEX to keep its speed bump when it becomes an
exchange, according to a person familiar with the SEC's thinking.
Though the commissioners will make a decision only after IEX applies
to become an exchange, the SEC is likely take into consideration
that the high-speed trading phenomenon and the proliferation of such
firms took hold only after the rules were written in 2005, the
person said.
IEX and the SEC declined to comment on the use of speed bumps and
their legality under the current exchange rules, called Regulation
National Market System (Reg NMS).
OPPORTUNITY AND FLEXIBILITY
The regulator's willingness to consider altering the rules
underscores growing worries about the potentially disruptive effects
of high-frequency trading. High-speed computerized trading has been
around since at least the late 1990s and has become a dominant force
in the markets since then, accounting for more than half of all
trading in U.S. stock markets.
Supporters of high frequency trading say these firms provide
essential liquidity to stock markets, as they always stand ready to
buy and sell stocks. They say the ability of such firms to quickly
spot and act on price differences across markets and asset classes
creates a more efficient market.
But critics say ultra-fast trading leads to unfair markets. In his
book, Lewis said that it creates a two-tiered system, where the
fastest firms can effectively front-run slower traders. IEX's speed
bump was featured in the book as a way to counteract potentially
harmful speed advantages.
Several regulators have said they have active investigations into
high-speed and automated trading, including the SEC, the New York
State Attorney General, the Commodity Futures Trading Commission,
and the Federal Bureau of Investigation.
In a June 5 speech, SEC Chair Mary Jo White questioned whether the
pursuit of speed in the markets has gone beyond the point of
benefiting investors and whether current rules are getting in the
way of trading venues designing systems to level the playing field.
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"A key question is whether trading venues have sufficient
opportunity and flexibility to innovate successfully with
initiatives that seek to deemphasize speed as a key to trading
success in order to further serve the interests of investors," White
said. "If not, we must reconsider the SEC rules and market practices
that stand in the way."
In a statement to Reuters, IEX Chief Operating Officer John Schwall
said, "We endorse SEC Chair White's recent statement that 'secondary
markets exist for investors and public companies, and their
interests must be paramount,' and continue to make that the focus of
what we build at IEX."
AHEAD OF ITS TIME
Since launching in October, IEX has said it aims to create what it
sees as a fairer, less complex market, while operating within the
current set of market rules.
The rule in question is a section of Reg NMS about automatic
quotations. It says exchanges must give trading firms the option of
immediately canceling orders that are not immediately filled. The
term "immediately", it says, "precludes any coding of automated
systems or other type of intentional device that would delay the
action taken with respect to a quotation."
Further, the rule says that to qualify as "automatic," "no human
discretion in determining any action taken with respect to an order
may be exercised after the time an order is received" and "a trading
center's systems should provide the fastest response possible
without any programmed delay."
About five years ago, Nasdaq OMX Group ran up against the same rule
when it sought to include a speed bump in one of its trading venues,
called PSX, according to a former Nasdaq employee who was involved
in those discussions.
Nasdaq nixed the idea after a presentation to the SEC, where the
regulator directed the exchange operator's executives to the rule,
which appeared to conflict with an exchange using such a device,
this person said.
Nasdaq declined to comment.
The source familiar with the SEC's thinking on the matter said PSX
may have been ahead of its time. The regulator now will likely look
at the IEX case with the perspective that Reg NMS was written some
10 years ago, the source said.
(Reporting by John McCrank. Editing by Paritosh Bansal and John
Pickering)
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