OPINION: Can Inefficiency Help Equities?
The 350-microsecond speed bump deployed by the Investors’ Exchange has been the most cantankerous market-structure issues in US cash equities since the NYSE attempted to keep its ‘slow quote’ a protected quote in the run-up to Regulation National Market Structure last decade.
The IEX designed its speed bump, which affects incoming orders as well as outgoing matched trades, to make it difficult or impossible for high-frequency traders to incorporate IEX’s best and last quotes into their routing algorithms. As a result, IEX clients will not experience the ‘HFT tax’ that they find in other market centers.
The strategy flies in the face of the long-held assumption that efficient markets are the best markets. The industry defines efficient markets as those with the tightest spreads, greatest transparency, and often the fastest.
By eliminating the third metric, market speed, IEX officials hope to generate deeper liquidity and greater transparency.
The alternative trading system has had a decent track record thus, but it can maintain or surpass its growth rate as an exchange? Of course, its leadership believes so.
But its advantage only will last as long as other exchange operators do not change their business models. And there’s the rub.
The three leading equities exchange operators, NYSE, Nasdaq and Bats Global Markets, each have multiple exchange tokens, which allows them to experiment with pricing and business models without having to go all-in on one particular experiment.
Nasdaq’s unsuccessful experiment to introduce price-size priority via its Nasdaq PSX exchange is just one example.
It would not take much for other exchange operators to implement their official speed bumps. Many have had de facto speed bumps for years, such as requiring all co-located clients to use the same length networking cable to connect to the exchange’s servers no matter where they were in the data center.
However, an outgoing speed bump provides the greatest challenge to market participants.
Having one exchange delays transmitting its best bid, best offer, and last trade data only complicates routing tables a bit than if three additional exchanges began delaying some of their quotes as well.
Imagine the calculations that would be needed to compute when four exchanges start competing over the length of their speed bumps. As long as each speed bump is less than a millisecond long, the staff of the US Securities and Exchange Commission views those delays as de minimis.
Would a 500-microsecond speed bump draw more liquidity than a 350-microsecond delay?
No one knows, but there definitely would be a reverse arms race to find out.
It is doubtful that it will come to this given the numerous market-structure pilots underway over the next few years and the economic clout that HFT firms carry on Wall Street.
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With Eugene Kanevsky, James Redbourn, and Joanna Wong, CLSA