Updated on November 18 at 5:28 p.m. ET
In his 2014 book Flash Boys, Michael Lewis introduced readers to Brad Katsuyama, a Canadian trader who was seeing the world of high-frequency trading for the first time. Katsuyama observed an entire market in which traders, using paid, privileged access to high-speed trading technology, made huge piles of money simply by getting in their orders ahead of everyone else. Lewis’s book sparked regulatory action, and in 2014 the New York Stock Exchange paid the SEC $4.5 million in penalties for providing these high-frequency traders an infrastructural edge to get their orders in faster.
In response to what he found, Katsuyama, along with two other traders, started IEX (which stands for Investor’s Exchange), a marketplace that uses a 350-microsecond “speed bump” so that all trades come in at the same time. “The speed bump is similar to technology deployed by other exchanges: coiled fiber between the point where some users connect to the exchange and the exchange’s trading systems,” says John Ramsay, the chief market policy officer at IEX. “But we use it to maintain a set distance between us and all of our users.”
IEX has so far been a fringe response to the prominence of high-frequency trading, accounting for only 1.4 percent of U.S. stock trades (IEX says currently their share for the month is a bit more than that—closer to 1.7 percent). As of now, IEX is something that traders have to actively seek out. But that may soon change: In September, IEX filed a request to the SEC seeking enhanced status in the eyes of the law. If certified by the SEC as a public stock exchange, IEX would start processing any general orders sent by traders for which it has the lowest price. That’s key, because one of IEX’s big claims is that its speed bump reduces the incidence of mis-priced securities. If IEX’s prices turn out to be lower, brokers might start going there to trade instead of places such as the New York Stock Exchange.
Currently there are 18 registered public stock exchanges in the U.S. The rest are called “dark pools”—private exchanges for securities trading. (Luminex, for example, is, like IEX, a dark pool devoted to deterring high-frequency trading.) Becoming an official stock exchange would put IEX in direct competition with other major U.S. exchanges, including the New York Stock Exchange and NASDAQ. If approved, IEX would be the first new standalone equities exchange in five years.
The proposal is not without its opponents. The comment period of IEX’s SEC application has been drawing criticism from firms, such as Citadel Group, as well as exchanges such as BATS Global Markets and the NYSE (which in its letter to the SEC compared IEX to a non-fat yogurt shop that served full-fat yogurt under false pretenses, referring to an episode of Seinfeld). And critics of Lewis’s portrayal have noted that not all high-frequency traders are predatory. Together, all these opponents say that IEX’s speed bump would be counterproductive.
Still, IEX has powerful backers. The company has raised $100 million from a wide range of investors, including Steve Wynn and Bain Capital, in preparation to become a public stock exchange. Other investors in IEX include the hedge funds Greenlight Capital and Pershing Square, as well as the venture-capital firm Spark Capital. And soon, IEX is expected to respond to its critics in the near future with more details on its speed bump.
James Angel, a professor of finance at Georgetown University’s McDonough School of Business, believes that U.S. stock exchanges are competitive enough that if one exchange isn’t providing good service, the market will correct itself and shift into other exchanges. “For this reason, the SEC should not be in the business of micromanaging the details of how stock exchanges operate,” he says. “Stock exchanges should be free to experiment with different ways of running their business.” Not only does Angel think the SEC should approve IEX’s proposal, but that it will. “It’s not a matter of whether they’ll be approved, it’s a matter of when and under what conditions,” he says.
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