Finally, An Interesting Attack On IEX!

Includes: ICE
by: Kurt Dew


An SEC decision to give IEX exchange status becomes ever more likely.

BATS CEO Chris Concannon has an interesting take on IEX exchange designation.

In spite of HFT howling, he thinks HFTs will benefit from IEX when it's approved.

That is a credible belief. And a fair warning to IEX.

I need to get some answers, some answers. I cannot guess anymore. Are you for real? Are you for real?

-- Zebrahead

I thought there was nothing with impact on market value of exchange management shares left to say. IEX's struggle to be designated an exchange by the SEC is nearly over, as time to the SEC decision is winding down.

If you have been following this saga, you know that IEX is the Lone Ranger of stock markets. It is the only putative exchange that does not get paid by high frequency traders (HFTs) to give them access to market prices before the public sees them. These HFT pet exchanges, the New York Stock Exchange, a subsidiary of ICE (NYSE:ICE), Nasdaq (NASDAQ:NASD) and BATS (BATS:BATS) have a great deal of value to lose, to judge from their complaints, if IEX is approved.

In fact, IEX proposes to slow down placed orders by sending them over a "speed bump," a length of cable that assures that orders arrive at IEX after the prices they are chasing do. This, it turns out, reduces the advantage that getting prices early from the sell side's pet exchanges provides HFTs.

One would think this is plainly a good thing. But the HFTs successfully raised the issue: does the welter of relatively obtuse rules the SEC has in place permit this IEX speed bump?

The sell side successfully distracted the SEC this way, and consequently delayed IEX's exchange designation. Facts have come to light since, such as the fact that the other exchanges had speed bumps themselves before IEX existed, that they installed without asking the SEC, that may have swayed the SEC in favor of IEX's exchange designation. I had the odds about 80:20 for designation until now.

But suddenly, I am more certain that the likelihood is very high that IEX will be approved for exchange designation by the SEC. How do I know that? Finally, one of the many critics of IEX, BATS CEO Chris Concannon, has said something he genuinely believes, instead of the usual half-truths and misleading comments emanating from IEX's opposition. According to Concannon,

Who takes advantage of anomalies like [the speed bump]? It's not going to be buy-side traders,

Concannon said at the Sandler O'Neill Global Exchange Conference in New York on Wednesday.

[IEX] will be riddled with HFT.

If IEX ends up helping the firms it planned to blunt, "there's great irony in that…"

I find that remark credible for two reasons:

  1. The remark shows great insight into the criminal mind, one of the essentials of being a trader. As I tell my students: "You don't have to be a criminal to be a competent financial professional, but you must have a criminal mind." If you don't see the distinction, you don't want to pursue a career in finance. The point implied by Concannon's remark is, "If it's complicated, it is easier to manipulate." And the speed bump is undeniably a complication.
  2. Concannon's remark does nothing to advance the case for IEX's opposition. The SEC is not going to turn IEX down because IEX attempted to use intellect, instead of SEC regulation. IEX did not resort to the sell-side pet exchange's rules, passed in the dark of night without SEC approval, to defeat HFT attempts to front-run other traders.

IEX will inevitably succeed only partially, and then only with great vigilance and further efforts.

In other words, in an unguarded moment, BATS CEO showed he understands the business and spoke his mind. The sell side is the sell side because they are paid to match wits with every player in the market, every single day. They are better traders than the buy-side traders. That a piece of cable will defeat them is a forlorn hope. They will find a way to profit from the cable's presence.

So I never thought it was the really the speed bump itself that bothers the sell side. There is a bigger reason why the sell side is so freaked out. They have been profoundly embarrassed. First, the sell side's pet exchanges have been well and truly undressed. There was a time when an exchange was genuinely a place where traders simply met to trade. (Have no doubt that it has generally been better throughout the centuries to be an exchange insider than an outsider. But exchange staff did not make it so.)

What has made it all a moral issue is that exchanges, naïvely, decided to make the transition from membership organizations to publicly held institutions. Now the weight of corporate law is upon them. And they were obviously not ready for prime time. Amazingly, sell-side pet exchange officials wax righteous about their blatant prostitution to the HFTs.

When the exchanges mistook themselves for something other than a utility, a place to trade, convincing themselves that they were market players, not market observers, they created the conditions that led to the creation of IEX to counter the broken system.

But this whole brouhaha has opened up an issue that I have seen no one discuss. The question is: Must IEX remain privately held? Will it be able to go public and remain IEX? In a recent interview, IEX CEO Brad Katsuyama relays the founding principle of IEX:

We wanted to build a company that reflected the mission we're on -- people who cared as much about doing good as they did about making money.

More than once, I have considered an IEX decision, and asked myself, would public shareholders approve? Could they sue? It's a close-run thing, I believe.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.