January 13, 2016
My firm is one of the more than 4,000 independent brokers in the United States. Operating in Texas, far from the heart of the market structure debate that seems to have raged incessantly for the past 10 years it is hard to feel anything but fatigue and disgust at the degree to which the arguments have escalated to a level of hyper minutiae. An arcane mix of law and technology has come to dominate the market structure discussion such that it is incomprehensible to regular people, which in turn breeds suspicion. The Main Street American investor simply cannot understand how three hundred and fifty millionths of a second is an increment of time that is important to anyone but the high-speed trading firms that are buying speed advantages from the exchanges.
The subject of latency arbitrage has been discussed for at least six years now, and probably goes back more than 15 years to the SOES Bandits even if it wasn’t called “latency arbitrage” back then. Periodically, seems at least one a year, a credible journalist lays these issues out in the most common sense terms: the exchanges sell high speed data and technology to a select set of firms that pay tens or hundreds of thousands of dollars a year for it, and those firms use the speed advantage to learn of changes in quotations ahead of everyone else – they have today’s news while everyone else has yesterday’s news. It seems that this is a well-known and accepted fact happening blatantly right in front of the entire market yet after a decade or more it is still happening unabated. Even though my clients continue to invest, they still feel there is a hidden seedy and unsavory tax being paid to the exchanges and high-speed firms.
My firm placed over 22,000 trades last year and I was watching Level 2 market data on a large % of those trades. I have frequently personally witnessed the bid and ask being manipulated with quotes we are attempting to access being moved away from the inside the second we place an order or disappearing entirely, particularly in less liquid securities. Phantom or fading liquidity is real in my experience and affects even retail sized orders. This is not an issue of supply and demand and market impact. There is something else going on. The supposed liquidity provided by HFT all but disappears in the moments where the market needs it the most, and it feels like a perpetual game of bait and switch just to execute a simple limit order. This has been evidenced by the two stock market flash crashes over the past 4 years and almost daily single stock flash crashes the past 5 years.
I am in favor of IEX receiving exchange approval and allowing my clients to participate in an environment that is not under constant manipulation by HFT. The investing public is well aware of the disproportionate amount of volume being done by HFT and this completely erodes investor confidence in markets and further perpetuates the belief that markets are rigged. The perception is that this is a pay-to-play game and that certain market participants are legally able to front run other market participants. Having experienced it first hand I am unable to offer reassurance that this is not the case.
This application process has devolved into the same exhausting micro-minutiae that has over the past 10 years made it impossible to resolve to any level of absolute certainty that one side is “right”, perhaps even for the SEC. However, as a “regular” broker representing “regular” investors my impression is distinctly that IEX has, through market-driven competition and innovation, sought to address some very specifically identified latency arbitrage problems with very concrete solutions, and to make those solutions available to the largest number of market participants to help them compete with the fastest firms without requiring them to spend hundreds of thousands or millions of dollars a year to save a few hundred microseconds. That might not be “fair” to the fast short term traders who have invested millions of dollars in speed, or to the exchanges that seem to have completely reoriented their businesses around selling speed, but even the SEC has acknowledged, and the law states that, the interests of long term investors must be paramount, in other words prioritized ahead of short term traders, intermediaries, and exchanges. However, if a decision about fairness is ultimately what this boils down to then, as a regular broker representing regular investors who individually or through large institutional asset managers compose the vast majority of the investors providing capital to the companies listing shares on the U.S. markets, it seems appropriate to remove some of the current purchasable and unfair advantages offered by exchanges and enjoyed by a minority of traders at the expense of the majority of investors. This seems a prudent course for the benefit and health of the market, and certainly for the perception of regular investors that they aren’t being cheated even in very tiny increments.
Regular people understand the IEX story and IEX seems to be one of the few players in the market trying to look out for their interests. One can’t help but marvel at the duplicity of the claims that their magic shoebox is at once marketing gimmick and threat to the entire market. It can’t be both, so maybe it’s neither. Their innovations aim to prevent orders from being picked off on their own market, and prevent latency arbitrage when trading on away markets. There seems to be a lot of hand wringing about the technical details of how they do that, but from here in Texas as far as I can tell they are the only market that has sought to reduce latency arbitrage while all of the others have sought to enable it, for a considerable fee. In fact, it seems like in the absence of such innovations ALL of the other exchanges must be, by definition, subjecting their customers to being picked off or latency arbitraged?
At some point the simplest explanation that a rational, regular person can understand is easier to trust than a wildly complicated and more “sophisticated” explanation – just take a look at the complicated products that caused the worst crisis since the Great Depression.
The SEC should grant IEX its exchange license to give investors and smaller independent brokers more choice in determining how to access the markets, and to make available to them tools that allow them to effectively access those markets without massive investments in technology and speed that have nothing to do with helping regular people plan and save for their futures through long term investing.