"This is just another step to change the way stock exchanges operate and service the industry," CEO Brad Katsuyama told me. "We're ready to start the next chapter in our evolution."
IEX has been operating as one of the 40 or so "dark pools," which are private trading venues. They're called "dark" because they generally do not display liquidity — that is, they don't display bids or offers — although a small portion of IEX's pools does. The stock exchanges — Bats Global, the NYSE, and NASDAQ — are, for the most part, "lit" exchanges that do display bids and offers.
The new IEX exchange is different from the other exchanges in several respects:
- The heart of IEX's strategy is based on a 350-microsecond delay in the time it takes for orders to enter and leave. They say this "speed bump" will prevent high-frequency traders from racing ahead of slower investors to take advantages of changes in bids and offers before they update. The speed bump, they say, will make it more difficult for high-frequency traders to withdraw their price quotes.
- The existing exchanges — particularly the NYSE and NASDAQ — strongly opposed the IEX's application to become an exchange, arguing that any "speed bump" would violate the spirit of existing regulations that require that all participants be able to access quotes at the same time.
- They lost. The SEC ruled that the 350-microsecond delay was such a small delay that it didn't violate any of its rules.
- There is a different pricing strategy. The other exchanges for the most part use a "maker-taker" model, where they charge a fee for traders to "take" or remove liquidity and offer a rebate to other traders willing to provide liquidity (posting bids or offers). The current maximum fee that can be charged is 30 cents per 100 shares.
- IEX does not provide rebates and instead charges a flat fee of 9 cents for every 100 shares on all trades in its dark pool. For its new exchange, the price will remain 9 cents for "dark" orders, but will be free on the "lit" market that displays bids and offers.
- Free? That's what they say. At least for the moment.
- They do not allow co-location, which allows some groups to pay to put servers near an exchange's matching engine to get pricing information more quickly.
One final point: Unlike Bats, IEX has indicated it will seek to get into the lucrative listings business to compete with the NYSE and NASDAQ. Listings are a serious business: They're about 12 percent of ICE's revenues, and 13 percent of NASDAQ's.
Will the new exchange succeed? Right now, it has less than 2 percent of the market share, but that will likely change. Becoming a "lit" exchange will certainly attract more volume, though how much of the new exchange will be "lit" is not clear.
Some traders that rely on rebates for trading profits may be reluctant to use the exchange, but Katsuyama says he's not worried. "IEX has to earn each order rather than paying a rebate to get it. And we do that by focusing on protecting the order and delivering high-quality executions. The rebate is very rarely passed onto the end client, so they don't care about the rebate. Their goal is high-quality execution, which is the same as ours."
If the buy side really gets behind IEX and insist that their brokers post on IEX (this has already happened to some extent), their volume will certainly go up.
How much volume they attract may determine the reaction of the other exchanges. The competing exchanges vehemently objected when the SEC ruled that a 350-microsecond speed bump was so small it didn't matter. NASDAQ considered suing but has now decided to offer a variant: They are planning to introduce a new order type that would reward those willing to commit liquidity to order books for a minimal amount of time — likely a second. This is not a speed bump: It would simply give priority to those willing to let the orders rest on the books longer.
Expect more variants to surface from other exchanges.
What does it all mean? It's a good idea to have a discussion about the obsession with speed. Whether it will ultimately make a difference is not clear. But it's good to have that option.