03.17.2020
By John D'Antona

Buy Side Supports IEX D Limit Order Type

There’s more going on in the stock market than either 100 or thousand point swoons.

On a deeper market structure issue, IEX has received some much-needed and appreciated support for its D Limit order type from twenty-seven institutional investors including Brandes Investment Partners, Northern Trust, Eaton Vance, Janus Henderson and the Ohio Public Employees Retirement System, the seventh largest pension fund in the US. The buyside consortium has submitted a joint comment letter to the Securities and Exchange Commission endorsing the IEX plan.

Together these buy side firms have a total $2.4 trillion in assets under management.

We join the undersigned asset managers to express our support of IEX’s D-Limit order type,” wrote Brandes Investment Partners in its letter to the SEC. “We believe it will diminish the effect of  latency arbitrage, encourage the provision of displayed liquidity without introducing significant unintended consequences, improve the current trading environment and foster a more liquid and stable market across the board’.

“In a trading environment that has increasingly gone dark, we believe the new order type proposed by IEX is a timely and badly needed innovation that goes to the heart of the market forces that have caused this shift and has market participants increasingly avoiding trading “out loud” (therefore weakening the price discovery function ofthe markets). We want to clarify that, while we are supportive of this order type on IEX, we encourage the Commission to consider different proposals separately and distinctly and with the same level of scrutiny that is being afforded to lEX’s D-Limit proposal.”

All of the 27 firms agree that D Limit and IEX would be promoting displayed orders – without simply offering a greater rebate or unfair option to select market participants. The important aspects of the proposal enumerated by those on both the buy and sell side have laid out a thoughtful case for D-Limit:

  • D-Limit addresses shortcomings ofthe displayed trading experience and brings true innovation to the lit markets;
  • D-Limit orders are non-discriminatory and offer protection for all market participants;
  • The proposal is tailored to effectively level the playing field for displayed orders;
  • The operation ofIEX’s CQI and the repricing of D-Limit orders are deterministic and transparent; and
  • D-Limit addresses the root issue of latency arbitrage, without adding confusion to best execution/pegged pricing processes.

On the sell-side, Goldman Sachs has also written a supportive letter to the SEC (link).

Jeff Bacidore, The Bacidore Group

The D-Limit order would apply IEX’s Crumbling Quote Indicator (CQI) to lit orders. The CQI uses a sophisticated empirical model that predicts when prices are about to change, effectively replicating the approach used by high frequency market makers and some broker algorithms to avoid being “picked off”. Specifically, as with their hidden D-peg order, the D-limit order would be re-priced to a less aggressive price whenever the CQI signals a deteriorating quote.[1] . Adjusting limit prices in the face of imminent adverse price changes helps to reduce adverse selection and enhance limit order performance. Indeed, IEX provides some compelling statistics to support the effectiveness of CQI, evidence which strongly supports the claim the CQI can be a useful tool in managing adverse selection.

“On its face, the D-Limit could add significant value by providing the broader trading community a means to compete with the more sophisticated, high-frequency traders when posting limit orders,” said Jeff Bacidore, founder of market consultancy The Bacidore Group. “But some unanswered questions exist surrounding how D-Limit varies across stocks, how it would perform in volatile markets – especially in times of market stress –and what impact a broad adoption of these types of tools across protected venues would have on the market as a whole.”

Jack Miller, Baird

Jack Miller, Head of Equities at Baird told Traders Magazine that part of Baird’s interest around the D-Limit order type, as well as its belief that the proposal can bring benefits to the markets, stems from his positive experience with utilizing other IEX order types that leverage the “IEX Signal”(the “Crumbling Quote Indicator” or “CQI”).

“For example, using the Discretionary Peg (“D-Peg”) order type has allowed us to rest on the IEX order book while also seeking to access liquidity at a more aggressive price except when the IEX Signal is “on,” thereby protecting our orders from trading in potentially unstable and adverse conditions,” Miller said.

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