In June this year, the Securities and Exchange Commission (SEC) officially approved the Investors Exchange’s (IEX) application to become a registered trading venue. Brad Katsuyama, chief executive officer at IEX, wrote a letter following the SEC’s decision said: “It’s been quite a journey…”
He added: “We have faced several obstacles along the way and we learned along the way, but we hope our partners realise that our team’s hearts and minds are in the right place”
The regulatory approval was a controversial decision and saw companies like Citadel and the New York Stock Exchange (NYSE) voicing their concerns. Nasdaq also threatened legal action against the SEC over its decision. We caught up with co-founders of IEX, Katsuyama and Ronan Ryan – president at the exchange – to discuss what has happened since it became a registered trading venue.
Hayley McDowell: You’ve been an exchange for a little while now, it was a controversial move and you received a lot of hostility from incumbent exchange groups like NYSE and Nasdaq. Are you experiencing that same hostility now and do you think your exchange status could be under threat due to this?
Brad Katsuyama: We don’t see any threat to the status, but what’s happening now is that the hostility has shifted back to being private rather than public. One of the benefits of the public comment to the Securities and Exchange Commission is that it allowed our supporters – Franklin Templeton, T. Rowe Price, even players like Goldman Sachs and Virtu Financial – to write positive commentary about IEX and why it should be approved. I think that forced the incumbent exchanges to publicly state their opposition to a market that was designed to protect investors. I think that for us it was an extremely interesting – and in some ways gratifying – process because it showed what was at stake.
After ‘Flash Boys’ a lot of people thought this was just marketing, but very clearly it does matter, to the extent that a competitor (Nasdaq) threatened to sue its own regulator over the approval of a new marketplace. We’ve been under attack since IEX was founded, so this is something we’re used to. I guess our critics feel that the only way to get your point across sometimes, if it isn’t based in fact, is to scream and shout. I think the rhetoric and the intensity of those opinions highlighted how weak their arguments really were. We were a little taken aback by how unprofessional it was to be totally honest.
Ronan Ryan: From our stance, we did take solace in such an attack because as Brad pointed out, prior to that a lot of our claims were deemed to be fiction and hype – so having people attack the specific parts of our model that we designed it for validated what we were saying. When we said that people are using acknowledgment of a trade and single digit microseconds to cancel their other trade intents on other venues, in 2014 people just said that doesn’t happen.
In some of the comment letters, people literally wrote that by finding out 350 microseconds after a trade occurred they would be unable to pull their quote. We had always said that we represent the institutions and when they are sending a trade from market to market, they don’t have the opportunity to cancel their order, but another side of the trade does. That’s what we wanted to equalise and I think we have proved that we do equalise that. It was great validation from those who do not support us.
HM: When ‘Flash Boys’ was published and IEX was founded, there was talk in the industry that high frequency trading (HFT) was becoming less of a concern for buy-siders. Do you think HFT is still a concern for buy-side investors?
RR: Too often the easy target in this conversation is HFT being good or bad for institutional investors. When you think back to before ‘Flash ‘Boys’ was published, we quit our jobs to set an up exchange specifically because the exchange is the centre of the ecosystem, and it is the exchanges enabling the activities of some of these players. This is a big problem and it continues to be the biggest problem in the market. From a HFT standpoint, we have always said that we are not anti-HFT but we are against the creation of advantages for some to the detriment of others. That’s what the exchanges have done.
There are many HFT firms that trade on IEX and there are many that won’t trade on IEX. When we designed our technology and our 350-microsecond delay, the whole point of that was to create an equaliser and allow everyone trading on IEX – whether you’re a slow or fast trader – you can both leave with a positive outcome. That was the thing missed in all of these arguments. I think market structure should be the concern for the buy-side in the US and Europe. The prevailing culprits in this – and we strongly believe this, which is why we put our money where our mouth is to set up an exchange – are the exchanges themselves.
BK: The buy-side is more aware that some aspects of HFT are good and other aspects are bad. Even internally at IEX we realised the buy-side are more aware of the difference in how firms act. What was gratifying during the application process is seeing a letter of support from Virtu Financial, which sharply contrasted other HFT firms that were attacking us. That shows there are differences in business models and HFT can’t all be painted with the same brush.
Universally, the concern has shifted from HFT to questioning the role of the stock exchange. The exchanges fighting back as hard as they did forces you to understand where their priorities lie, because they are increasingly dependent on selling data and technology advantages. That has a negative impact on all players. I think the other aspect of a shift in focus towards the exchanges includes publically traded companies as well. They saw that application process and we had a lot of calls asking why their shareholders are supporting us but their listed exchange is attacking us. They questioned why there wasn’t an alignment between those two parties, and I think that gave us a good window of opportunity to explain the stock markets to a lot of people who had been left in the dark.
HM: IEX is aimed at helping the buy-side but market share remains relatively low. Do you think any exchange specialising in servicing the buy-side can achieve significant market share vs. Bats, NYSE and Nasdaq?
BK: In context, we hold 2% when the largest exchange holds 14%, and we are reasonably happy with where we are and I think we have a lot of room to grow. At the end of the day, the originator of the orders – the buy-side and the brokers – is the most important player in the ecosystem. I read a quote recently from a high-speed trader who said, “If you put all high-speed traders on the same exchange, there would be no trading.” This is true because they are there to interact with real liquidity and other investors. For us it’s about educating the end investor and rallying them together in a fair and totally transparent way that is aligned with their interests, so that they want to trade on IEX.
The challenge that we face – and I think we are up for this challenge – is the rebate structure. Exchanges pay $2.5 billion a year to their members to send them orders and we don’t pay rebates. Instead we are creating better outcomes for clients, we run analysis of publicly available data showing that the execution quality on IEX is higher than on any other exchange. If 50% of the end users in the market decided to send their orders to IEX, we would be something close to that percentage of the total market.
The best part about the future for us is that this is in the buy-side’s hands to fix and I think the more educated they become, the more data they can analyse and the more they understand the incentives in this market, they will see a greater incentive for them to want to continue to work with us. That for us is very encouraging.
RR: The data is absolutely critical and we are 2% and immensely proud of that. We have only been an exchange for a couple of months and what is very different around that is when we were an ATS and if we wanted to compare ourselves to other ATS’S & dark pools, it was basically impossible to do so because there’s not much transparency among individual dark pools.
As an exchange there’s something called TAQ data, which allows us to compare ourselves against other exchanges, and this is irrefutable and can be pulled by anyone. So far, the data is proving that we have the best execution quality.
Separate to that, buy-side traders care about block trading and mid-point execution, we’re still trading over 50% of our volume as a continuous market at mid-point and we are executing more blocks than any of the current exchanges. So, we’re doing exactly what we want to be doing and what the originator of the orders wants us to do.
HM: Does IEX have plans to branch out into other asset classes or into Europe?
BK: We have looked at other asset classes but the opportunity in US equities is big and we haven’t found – at this point in our company’s growth – another opportunity that is as big enough in front of us.
We get asked about whether we will expand into Europe a lot and our stance on that is similar to branching out into other asset classes. We will focus on US equities and perhaps further down the line it would be considered, but it’s not something that we have on the road map. We go to Europe a couple of times a year and there are a lot of institutional investors that trade US equities and have been big supporters of IEX. It’s certainly something we will look at further down the line.
RR: The European buy-side has been a very engaging group in this for the last few years. Their progressive knowledge of market structure and interest in IEX has been really humbling. We enjoy going over to Frankfurt, London or Paris and meeting with the buy-side there.
HM: Based on feedback from your members, what do they like about what IEX does and what do they feel could be developed or done differently?
BK: When we talk to the buy-side and the brokers that trade on their behalf, the focus is on execution quality. Interestingly enough, a lot of the things IEX has implemented that differentiates us – like the speed bump – was designed to avoid trades that are extremely adverse to one category and ensuring that we are trading on their conditions, so our focus continues to be on execution quality.
A lot of people will say they like the fact that IEX’s market data is free or the fact that we don’t pay rebates, but then say they don’t like the speed bump. That opinion is very impractical because if we didn’t have the speed bump then we would look just like any other exchange. If we were like any other exchange, then we would have to pay rebates because how else would we get someone to send us an order? If it were not for execution quality, then we would have to pay them. If we pay them, then we have to charge for market data, so all these things work together.
As an exchange, you’re either fully committed to representing and protecting the interest of investors, or you’re not. And the exchanges chose different priorities and it’s their business right to do so, but I think half-in and half-out is completely disingenuous.
RR: The exchanges have their business model and it is what it is, but truly when you speak to the institutional investors, the buy-side and sell-side brokers that represent them, they know for sure that we have got their back. Our business model is an overall philosophy and nobody questions that when we meet with them. While other exchanges are attempting to reach out to the buy-side, you can clearly see where the interests match up and IEX certainly matches up with their interests. The other exchanges’ interests do not and that is just a fact.
HM: You hired Sara Furber as your new head of listings. For those looking to list on IEX instead of NYSE or Nasdaq, what do you tell them?
BK: A lot of companies have been very frustrated with the lack of information on how the market actually works. Some of them believe Nasdaq or NYSE are the largest exchanges, but they aren’t trading 85% of trading volume anymore. The largest exchange in fact holds 14% of the volume. It’s much the same way that we built our relationship with the buy-side, we didn’t say anything other than what we know to be true. It’s about educating them about what’s going on, how it affects them, how it will affect their shareholders and this is what we are doing differently.
There has been a very positive reaction to an increasing education about what’s happening. Similar to the buy-side, once you realise where the priority sits and where the alignment is, it starts to develop relationships that are based on a mutual trust. The relationship with the buy-side developed over many years, and we are going to take the amount of time necessary to earn that amount of trust with issuers.
Surprisingly, the conversation ends up with the issuers saying that Nasdaq and NYSE are more similar than they are dissimilar. Both are highly electronic, they all take rebates, they have specialised order types and they all make more money from selling market data technology than they do from actually trading. They are very similar, but IEX is different and I think that helps start the discussion. We are in the early stages but Sara Furber was an incredible hire for us and we’re super excited to have her on the team.
RR: An interesting dynamic in all of this is historically an issuer has a choice of two exchanges, and many would ask shareholders does it matter where I list and the answer was always no. They are getting different answers now. We are excited to disrupt a 45-year old duopoly.
HM: What are your focuses for 2017?
BK: Execution quality and listings are our two main focuses. It’s data driven analysis focused on quality of execution and listings. I think people will be surprised at the poor execution quality on the exchanges that pay the highest rebates.
RR: It comes down to proving how the experience will lend itself to bigger market share, which is why we aren’t consumed with market share on a daily basis. We are growing rapidly and we expect this to continue.