Within the next two weeks, the Securities and Exchange Commission (SEC) is expected to announce whether it will approve or reject IEX’s application to become an exchange. The regulatory agency’s deadline for the decision is June 18. Thus far, IEX’s claim to fame has largely been being the subject of Michael Lewis’ Flash Boys: A Wall Street Revolt. The book details the evolution of the securities trading industry and the growing practice of high-frequency trading (HFT). IEX is positioned as a champion for the traditional investor, developing an alternative trading system (or a dark pool, which definitely sounds both cooler and more ominous) that implements a slight delay so that everyone is theoretically on an equal playing field. Mind you, the timeframe that we’re talking about here is tenths of a millisecond. You literally can’t even blink that fast.
In September 2015, IEX applied to the SEC to become an official exchange. This has sparked months of contentious debate, much of it playing out in the public arena, on the impact and fairness of IEX joining the ranks of the NYSE (ICE), NASDAQ (NDAQ), and emerging BATS (BATS). The whole debate is very inside baseball, but it’s inspired a deeper look into just how byzantine and fragmented the trading industry really is.
While most people recognize the NYSE and Nasdaq, there are over a dozen other exchanges operating that they probably have never heard of, and about another dozen and a half dark pools in existence in which transactions are traded privately away from everyone else. High frequency trading is basically just a lot of trades being made very, very fast.
The issue is that HFTs can essentially front-run slower trade orders and arbitrage profits, leading to accusations of the market being “rigged.” Simply put, HFTs can see large orders before they’re executed, and as a result, jump in the middle of the trade to squeeze out a small profit. Multiplied several million times over, and the strategy can generate billions of dollars. The counter argument for HFTs, however, is that based on the speed and volume in which they trade, HFTs may be providing much-needed liquidity to the market. And on an individual basis, the profits are so miniscule that most average traders and investors wouldn’t even notice.
The IEX Solution and Ensuing Conflict
IEX’s solution to this issue is to add a “speed bump” to delay orders by 350 microseconds, running them through a “magic shoebox” that consists of a 38-mile coiled fiber-optic cable, cable length and positioning being the lifeblood of trading speed.
This has irked quite a few players in the industry, to say the least. Heads of the NYSE and Nasdaq have been outspoken with their opposition, with Nasdaq even raising the possibility of suing the SEC should it grant IEX exchange status. You can read the hundreds of public comments industry participants have made to the SEC’s review process on IEX here.
The issue at hand is that stock exchanges regulated by the SEC, like NYSE and Nasdaq, are currently required to process trades “immediately,” and allowing IEX to be the only exchange with a speed bump would theoretically give the startup a monopoly on the feature. The SEC’s justification is that the 350 microseconds is considered “de minimis,” or negligible, since it’s under 1 millisecond. But this creates a slippery slope as well. If IEX is approved, then the SEC would likely have to expand the de minimis rule to the other exchanges.
On the surface, that doesn’t seem like a big deal, but in the world of lightning-fast trades, anything under 1 millisecond is a large spectrum. Exchanges can set their speed bumps to 001 microseconds or 999 microseconds. Considering how complex trade routing already is, as well as the amount of unintended latency that already exists, this decision could have significant implications on how the market will be structured going forward.
Who would’ve ever thought 0.00035 of a second could be such a big deal?
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