04.10.2015
By Terry Flanagan

Michael Lewis Expects IEX to Overtake NYSE

Michael Lewis, author of controversial book Flash Boys, expects the trading platform IEX Group to be bigger than the New York Stock Exchange in five years.

Lewis spoke at the Royal Festival Hall in London yesterday in an event presented by Penguin Live and 5 X 15 on the paperback publication of his book, which raised hackles when it claimed that US stock markets were rigged in favour of high-frequency traders.

The book tells the story of Brad Katsuyama, who started investigating problems with equity trading when he worked at the Royal Bank of Canada and has since launched IEX Group, a trading venue which aims to favour long-term investors and was seeded by a consortium of asset managers. Lewis said: “The news is that someone on Wall Street decided not to make money from the problem but set out to fix it. That is really unusual behaviour.”

Lewis said regulators have begun investigations into HFT since the publication of Flash Boys, but market forces will ultimately cause change.

“I am not sure how serious these investigations are, although the suit from the New York Attorney General is very serious,” Lewis added. “The exchange they have built [IEX] is flourishing, it is making money, venture capital is being thrown at them and investors can measure savings which creates market forces.”

Lewis said that one mutual fund manager had told him they saved a third of one per-cent from sending trades to IEX. “This does not sound like a lot but they trade $80bn of stock a year so just one firm has saved $240m,” Lewis added. “The market is moving and five years from now IEX will become bigger than the NYSE because people trust them.”

In the U.S. Equity Market Structure “Flashback” survey in March from Convergex, a global brokerage company based in New York, 57% of respondents said markets are not fair for all participants – although this has fallen from 70% last year. In addition 36% of respondents described HFT as “harmful” or “very harmful” to investors, but this has also reduced from 51% a year ago.

However the number of respondents who have changed how they interact with markets because of the ongoing HFT debate has almost doubled from last year to 42%.

Eric Noll, president and CEO of Convergex, said in a statement: “While Mr. Lewis cited our 2014 survey in his new Vanity Fair retrospective on Flash Boys, investors’ perceptions have clearly changed in the intervening eleven months. While our industry continues to grapple with a complex and challenging market structure, volatility has remained at historically low levels, the S&P 500 is up 12% since this time last year and we’ve seen the largest IPO ever go off without a hitch.”

Next year Europe will see the launch of a trading platform for long-term investors from Plato Partnership. The consortium of asset managers and broker dealers will use the revenues to fund academic research into improving equity trading. Last month Plato announced the inclusion of four more asset managers in the consortium – AXA Investment Managers, Union Investment, JP Morgan Asset Management and Fidelity Worldwide Investment.

Last May, Rebecca Healey, senior analyst at consultant Tabb Group argued in a post on the Tabb Forum that the situation was different in Europe as it does not have the US’ Regulation NMS and best execution responsibility falls on the buy-side.

“That is not to say that all participants are happy to engage with HFT; but rather, as a result of changes to regulation and the loss of traditional market makers, HFT liquidity may be the only liquidity available,” she added.

Healy also took issue with Lewis’s claim that asset managers do not understand market structure.

“The hapless bunch of individuals he portrays is not representative of the institutions I speak to in Europe,” she said. “The claims that the buy-side have been ripped off for years may have held sway a decade ago, but I have sat in countless meetings with buy-side and sellside firms and vendors – all working together to improve the marketplace through the Fix Trading Community and other industry bodies.”

The proposed MiFID II regulations for Europe cover algorithmic and high frequency trading.

The European Securities and Markets Authority has defined algorithmic trading but has given the European Commission three choices for defining high message volume. Law firm Ashurst said in a briefing note: “Esma says that only proprietary order flows should be included. There is a clearly a concern that some large investment banks will be captured by the thresholds (aimed at smaller HFT players), so if their flow is not proprietary, they are allowed to challenge the classification.”

Trading venues also have to set a maximum ratio of unexecuted orders to transactions, which cannot be exceeded, and algorithmic traders will be required to act as market makers.

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