The Tortoise and the Hare: IEX Puts an Age-Old Story to the Test
Speed, speed and more speed. For more than a decade, Wall Street has relentlessly hunted faster ways to trade. Millisecond trades became microsecond executions, and those were replaced with nanosecond latencies. Fiber networks turned into microwaves and then into lasers, all aiming to offer the fastest route to an exchange.
The need for speed, and the dollars required to get it, created a two-tiered system at U.S. exchanges that some people say isn’t fair for investors who trade at a much slower clip. Others say the system promotes pricing stability by enabling market makers to do their job. What we know is that speed has made fast traders a lot of money over the years, and it’s added a laundry list of terms to the Wall Street lexicon: Regulation National Market System (Reg NMS), smart routing, crossing, IOIs, the algo, dark pools, colocation, high-frequency trading, stolen Goldman Sachs’ code, Mahwah, naked access, latency arbitrage, The Quants, flash crash, flash orders, Flash Boys…and now, the speedbump.
Next month, the Investors’ Exchange (IEX) will become the newest exchange governed by the U.S. Securities and Exchange Commission’s Reg NMS, a rule that triggered a decade-long race to zero trading latency. IEX will be the first exchange during that time to systematically slow orders down. It’s adding a 350-microsecond delay, a.k.a. speedbump, which IEX executives say will level the playing field between fast traders and everyone else.
This is a marketer’s treasure. It checks all the right boxes: to be first, to be contrarian, to have a simple story about who should care and why—and maybe, to be right.
Why might a speedbump work? In part, it’s because of how the market responded to Reg NMS. The rule essentially daisy chains all public markets together and requires them to either have the best price for a stock or find the exchange that does and route the order there. When it was enacted in 2005, it sparked an arms race among exchanges and trading firms, alike—traders could choose to be responsible for routing to the best price, and many did. The faster you were able to publish new quotes and execute better trades, the more money you could make.
As things sped up, slower traders (typically institutional investors and asset managers who trade on quality rather than quantity) began to avoid public markets when they could. They began hiding their orders across dozens of so-called dark pools, which let them tell the market about trades after the fact rather than while they were happening. Investors were concerned that fast traders could identify slow orders coming to an exchange, race ahead of them on faster networks and swing prices in their favor. Investors didn’t like that.
Enter the speedbump, the cornerstone of IEX’s model, designed to resolve this perceived weakness in the U.S. market system. It’s brilliant in its simplicity: it’s a coil of fiber that every order goes through, a single-lane road with no room to pass. To be successful, IEX will have to build market share. To build market share, it’ll have to consistently have the best price. And if the exchange can do that, it’ll be a game changer.
What fascinates me about IEX is that it’s not trying to be everything to everyone. It’s trying to solve a need that is being underserved by the market. It’s marketing 101: find a need and serve it. And that’s why I’m betting it’ll work.
Photo Credit: Internet Archive Book Images, Flickr.
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