Earlier this week when we reported that the SEC staff had unexpectedly granted approval of the IEX exchange, the culmination of a long battle between free and unrigged market supporters on one hand and the HFT lobby and the NY Fed's "arms length" HFT operation and gargantuan retail order internalizer better known as Citadel on the other, we warned not to get too excited: "it is possible that the final vote will contain some variation on "protected quote" clause, thereby giving IEX its long-awaited exchange status but stripping its clients of the much needed anti-HFT protections, which are precisely the reason why so many vocal supporters of IEX have emerged in recent months."
We were wrong: in a late vote on Friday evening, the Securities and Exchange Commission voted to certify IEX as the U.S.’s 13th national stock exchange, giving the startup a license to challenge the Intercontinental Exchange, Nasdaq. and BATS. More importantly, the SEC’s decision resolved a clash over whether its rules, which sped the transition to fully electronic markets, allow IEX to use a “speed bump” that slows orders by just 350 millionths of a second, as popularized in Michael Lewis' book Flash Boys. Ultimately IEX will get unconditional status.
We were also partially right on the "protected quote" debate: as the WSJ writes, SEC Chairman Mary Jo White, and Commissioner Kara Stein, a Democrat, approved IEX’s bid. Republican Commissioner Michael Piwowar backed the broader move to approve IEX as an exchange, but dissented from a decision to give IEX what is known as a “protected quote,” which - as noted above - requires brokers to send orders to IEX when it shows the best price across all 13 national stock exchanges.
Having won approval, IEX will effectively become the first HFT-free venue, and will likely attract substantial institutional interest as the risk of being frontrun by HFT parasites is no longer present. Ironically, its competitors had said that IEX' model threatens investor benefits, when the reality was precisely the opposite.
Citadel and high-frequency trading firms deluged the SEC with letters that argued IEX’s speed bump would violate rules that require orders be “immediately accessible” to traders. Intercontinental Exchange Chief Executive Jeff Sprecher, whose firm owns the New York Stock Exchange, told analysts in February that granting IEX permission would be “un-American” because it would create a new “monopoly,” with IEX as the only exchange with a speed bump.
Citadel’s founder, billionaire Kenneth Griffin, got personally involved in the fight against IEX, meeting with the SEC as recently as June 3 to lobby against its exchange bid, according to a regulatory notice.
We are delighted, if stunned, that the SEC disagreed. That said Citadel's anger was palpable: “Today’s decision will test and potentially reverse the gains in fairness, efficiency and transparency that have been made to our markets over the last decade,” Citadel said. “We must be vigilant to identify unintended consequences, and firm in our commitment to equitable and consistent treatment for all investors.”
What is surprising is that it is well-known among market participants, and originally reported here, that the NY Fed transacts by way of Citadel at key market inflection points, when bursts of momentum ignition out of the Chicago HFT powerhouse prevent ther market from tumbling when they break a downward spiral in prices. A question thus emerges if the SEC's snub to Citadel was also an indirect snub to the NY Fed and market manipulation.
While it remains to be seen what the SEC's rationale was for granting IEX exchange status, one possible explanation is that even the SEC had noticed the unprecedented collapse in investor and trader interest, especially at the retail level, as the topic of how rigged the market has become is now a daily occurrence. As such the SEC felt compelled to take a stand. Or maybe not, and there is some other ulterior motive. We hope to find out.
For those unfamiliar with the IEX story, the exchange says its 350 microsecond delay is just long enough to protect investors from predatory high-speed trading that can front-run the orders of slower investors. Opponents such as Citadel LLC, the hedge-fund manager and electronic market maker, had warned that any delays would create stale prices and the potential for manipulation.
“It does mark a pendulum shift where ‘speed is king’ may have reached the furthest point it can go,” said Andrew Upward, head of market structure at brokerage Weeden & Co. “They’ve had a victory in this debate about the importance of speed in markets, and it’s a setback for those who think speed and efficiency are the end all and be all.”
On its website, Brad Katsuyama, CEO of IEX wrote the following letter of gratitude:
To our Sell-Side and Buy-Side Partners,
On behalf of the entire IEX team, I would like to sincerely thank you all for supporting us throughout our application to become an exchange. We are thrilled that the SEC has approved our Exchange Filing which puts us on track to commence a symbol-by-symbol roll-out on August 19th, concluding on September 2nd.
It's been quite a journey from working in a windowless room with no money in 2012, to launching our ATS, and now completing the lengthy (and I'm sure for many…tiring) Form 1 process.
We have faced several obstacles along the way and we learned along the way, but we hope our partners realize that our team's hearts and minds are in the right place – our goal is to bring real competition to the exchanges by challenging the rising cost model for data and technology while also protecting investors and delivering superior execution quality.
The IEX team is extremely excited about the road ahead, and we are grateful to be in the position to improve fairness, simplicity and transparency in our industry.
Thank you again for your support.
That said, the SEC’s decision may not be the end of the fight. Last month, attorneys for Nasdaq argued that the SEC could be sued if it approves IEX. The lawyers said the SEC would first have to change its own rules to explicitly allow for a speed bump. Absent that step, the lawyers wrote, the SEC lacked the authority to approve IEX’s proposal.
To this, the SEC issued an interesting response: addressing concerns about the legality of speed bumps - widely used by most of IEX's exchanges however in an inverse way, where premium paying clients are exempt from delays which are then abused by HFT frontrunners, the SEC separately said that delays of less than one millisecond (less than the time it takes to blink an eye) are consistent with its Regulation NMS. This is what the SEC said in its updated guidance under Reg NMS:
The Staff believes that, consistent with the Commission’s interpretation regarding automated quotation under Rule 600(b)(3) of Regulation NMS, delays of less than a millisecond are at a de minimis level that would not impair fair and efficient access to a quotation, consistent with the goals of Rule 611. The Staff’s view is informed by the efficient operation of the markets and the geographic and technological latencies experienced by market participants. Today, a one millisecond intentional access delay is well within the current geographic and technological latencies already experienced by market participants when routing orders between trading centers. Accordingly, the Staff believes that such a delay would be de minimis and consistent with the Commission’s interpretation of “immediate” as used in Rule 600(b)(3) of Regulation NMS.
The Staff notes that the Commission’s proposed interpretation included guidance reflecting a sub-millisecond standard. Though the Commission did not adopt that guidance as part of its final interpretation, the Staff notes that commenters on the proposed interpretation were divided on the appropriateness of an intentional access delay but did not advocate for a different specific standard. Further, the Staff believes the sub-millisecond standard is a reasonable line to draw, as it is broadly consistent with the latencies experienced by market participants today when routing orders around the primary exchange data centers, and is well within the maximum geographic latencies experienced when routing orders to the most geographically remote exchange data center.
The Staff acknowledges that market participants using the most sophisticated technology may today encounter access delays of substantially less than one millisecond when accessing the quotes of a single exchange whose data center is co-located with their own or located nearby. However, even the most technologically advanced market participants today encounter delays in accessing protected quotations of other “away” automated trading centers that can substantially exceed one millisecond, that either are transitory (e.g., as a result of message queuing) or permanent (e.g., as a result of physical distance). In today’s market environment, the Staff considers that intentional delays of less than a millisecond in quotation response times are de minimis in that they would not impair a market participant’s ability to fairly and efficiently access a quote, consistent with the goals of Rule 611. While the Staff believes that intentional access delays that are less that one millisecond are de minimis, that does not necessarily mean that all intentional delays that are one millisecond or more are not de minimis.
The technical interpretation of the above is that according to the SEC, IEX's 350 microseconds delay is negligible, and thus the market is automated and the quote is protected.
The far more important practical interpretation, is that the SEC has set a ceiling for what it deems the speed race among HFT firms, which over the past decade have moved from fiber optics, to microwaves to lasers in their endless quest to be faster and quicker than their competitors in order to frontrun them.
Well, no more, because with its decision, the SEC has capped what technological advancement in trading can achieve going forward, as now a 350ms delay will become the norm, while anything below 1 millisecond is deemed a de minimis delay.
This is catastrophic for HFTs for whom microseconds mean all the difference between profit and loss.
And once the vast majority of the trading public shifts over to IEX which is by definition HFT free, it will mean that the HFT scourge, already having largely cannibalized itself over the past several years, is about to end.
This is tremendous news, as it puts to rest a key part of our crusade launched in April 2009 when we first explained just how destructive for market functioning HFTs really are.
Now we can shift all our attention to central banks, the last remaining violator of free and efficient markets.