December 15, 2015
Attn Brent J Fields,
Secretary,
Securities and Exchange Commission
Dear Mr. Fields,
I am writing you today to discuss the IEX exchange application currently out for comment.I apologize for the incompleteness of my comments, but it is virtually impossible to comment intelligently on an application that is so thoroughly devoid of necessary details.
In 2009 the SEC, in the long lost equity market structure review document, reemphasized that fair and functioning markets should contain certain universal features. Those features were:
1) Efficiency - markets should strive for the economical and efficient execution oftransactions
2) Fairness - Markets should foster fair competition among like participants (brokers, markets, vendors...)
3) Transparency - The rules and functionality, along with the current quote should be transparent, but the intents of investors should not be
4) Practicality - The rules put forward should be practical, and fairly easy to implement. (The pilot study data requirements would be an awesome example of the regulators badly failing on this front(.
5) Intermediation - A functioning market strives to lessen levels of intermediation, not increase them.
As we consider how the IEX application - devoid of necessary detail as it is - maps out against these goals, we note that out letter, and the comment process as a whole, is about IEX. It is not meant to be a mechanism to throw other markets - deserving as some of them may be - under the bus. Liikewise, we not that regulators should not approve a flawed mechanism just because other markets have different flaws. This application should be considered on its own merit. The IEX folks would be better served explaining how their own market will work, than highlighting how other competitor markets operate....and we urge them to submit an application that truly meets that standard of a U.S. lit exchange, rather than spend the majority of their time throwing other businesses under the bus.
Our key concern with IEX concerns the manner they treat their broker dealer order routing subsidiary. As we understand it, although this is not made clear in the application, orders routing out of IEX using the IEXS routing solution will not be subject to the POP on the out leg, while other routing solutions will be subject to this. In fact, we are lead to believe this is currently the case with the IEX ATS, which is disappointing as it means that IEX's answers to us, during out investigation of the dark offering, were technically true but contained serious lies of omission.
Why does the differing standard matter? Well there are a couple of key reasons.
Firstly, by granting advantage to one broker dealer (and in particular you own BD) creates an unlevel playing field and grossly violates the goal of fair competition between dealers. IEX offers their routing platform for free - although this may change in the future - but control the routing table, giving themselves the ability to offer an advantaged product, gain routing share and use that share to negotiate routing tables with other markets for economic advantage.
Secondly, the lack of transparency in the original - highly touted - form ATS, and now in the exchange application is a travesty. Given the energy that IEX has spent bad mouthing other market participants around transparency, i don't think it is too much to ask that the exchange application actually detail how the exchange will operate. Even the NYSE and Nasdaq do this currently. What else is IEX trying to hide?
The real issue stems from IEX's decision - which again is not detailed in the application - to delay sending trading information via direct feeds. As a result participants will be able to take the offering on IEX, and using the IEX router ping away mid point matches before those pools will have access to said trade information. As such, the IEX router is designed to be able to ping other mid points at a stale quote, creating - not eliminating as their spin doctors to regularly state - opportunities for latency arbitrage.
Lets walk through this slowly, as the vast majority of commenters on this file are clearly not well versed in intricate market structure. If the market on XYZ stock is 25.10 - 25.12, and I send a spray route to all markets with a 25.12 quote, with an oversized portion to IEX the following happens.
1) I exhaust the quote on all visible markets at 25.12
2) my oversized order to IEX, uses their advantaged router to route out to other midpoints, with the order arriving at Bats Mid, or Bids mid, or XYZ mid before that market can possible appreciate that the IEX quote has changed....as such they still consider the offer to be 25.12, and misprice their mid points accordingly.
So how does the world react...we everyone adds a speed bump, and allows only their own router to avoid it. Each market makes their speed bump just slightly longer than the last market, to ensure their own mid point is properly informed, to prevent the IEX enabled latency arb. This leads us down a path of multiple speed bumps being introduced to invalidate the advantage IEX is giving their own router - and will force dealers to router to a variety of market place routers, creating complexity and intermediation that is totally unnecessary.
Worse than that, after all the markets have played the speed bump inflation game, we end up with quotes that are indicative at best, and router performance that is a joke. This has serious knock on impacts as market makers in other asset classes can't quote markets that are as tight or deep, due to the inability to effectively consume quotes on the hedging leg. Options markets, which are already suffering massive reductions in quoted liquidity, will become thinner and more fragile. Equity futures markets will also see spreads widen and depth disappear as market makers are unable to hedge effectively at the lit quote.
While the hundreds of single paragraph emails solicited by the marketing department of IEX are impressive, they lack information, intelligence of logical consistency. The well thought out arguments clearly indicate a market that is supplying a related company with an unfair advantage, doing so in a non transparent manner, forcing a market wide response that is impractical, harms liquidity and increases levels of intermediation. In short, this application violates every one of stated goals of a properly functioning market.
IEX needs to first submit an application that is worthy of consideration and debate, and then needs to focus on the impact their own offering will have on markets rather than slinging mud at those who dare speak out against it.
If this application has done anything, it has clearly highlighted what a dysfunctional disaster the US markets have become, relative to other developed countries, thanks to a lack of operation transparency and rules around fair access.
I strongly urged the SEC to resist the emotional urge to approve the IEX application until they have submitted something that meets reasonable standards, and they have addressed the issues around fairness and latency arbitrage enablement that come with the current offering - or at least what we believe the current offering to be, in lieu of a reasonable application.
Kevin M Weldon