In the wake of the U.S. Securities and Exchange Commission approving buy-side sponsored dark pool IEX’s application to become a full-fledged stock exchange, the question is what happens next.
In the opinion of one securities attorney, maybe not as much as people think.
Chris Greeley, partner at Herrick, Feinstein, said that the addition of IEX to the exchange roster won’t change the trading landscape definitively as the firm’s proponents say it will.
The SEC approved IEX’s application last Friday, by a 2 to 1 margin. SEC Chair Mary Jo White said the approval promotes competition and innovation, “which our equity markets depend on to continue to deliver robust, efficient service to both retail and institutional investors.”
The Commission’s interpretation applies to the Order Protection Rule under Regulation National Market Structure, which protects the best-priced automated quotations of certain trading centers by generally obligating other trading centers to honor those protected quotations and not execute trades at inferior prices. Under Regulation NMS, an automated quotation can be executed immediately and automatically against an incoming immediate-or-cancel order.
White said that the SEC’s updated interpretation of the Order Protection Rule means that a small delay, such as IEX’s, will not prevent investors from accessing stock prices in a fair and efficient manner consistent with the goals of the rule. “In doing so, the Commission interprets the term “immediate” under Rule 600(b)(3) of Regulation NMS as precluding any coding of automated systems or other type of intentional action that would delay access to a security price beyond a de minimis amount of time.”
SEC staff in its guidance to the full Commission reviewing IEX’s so-called speed bump, stated that delays of less than one millisecond can be considered de minimis.
Greeley said market participants who want to trade away from the low-latency crowd of high-frequency traders and arbitrageurs may take a liking to IEX. But the highest-speed traders are said to generate upwards of 60-70% of total trading volume, so by not routing orders to IEX, many could find it difficult to get their orders executed as a result of IEX design.
“IEX expects to pull significant volume from people that want to avoid algo traders, and most traders need to follow volume,” he said.
“The second problem is that best execution requires someone trading on behalf of customers and exchanges routing orders to hit the best offers,” Greeley continued. “So if IEX has the best price, that’s where the trades have to be done. Funds are in an arms race to cut milliseconds off of their algos – that is how they compete against one another, but this slow down only effects that portion of the world. But for all the little people pushing for IEX to level the playing field, it is like arguing changes to cricket rules – the people arguing don’t really understand the rules and the changes don’t affect them.”
So who will trade on IEX? Greeley said that there will be a class of investors, likely pension funds, who trade in vast size and will want to use IEX this exchange because they often rebalance their portfolios and don’t want to pay a tax for that.
“Although this assumes that the pension fund is using its own algo to rebalance and HFT will still exist, even on IEX, so the common guy placing an order through TD Ameritrade is still not on level footing,” Greeley said. “A lot of business will stay with the exchanges where they have financial incentives to do so.”
Greeley also said that IEX’s battle to be an exchange player continues to be overshadowed, at least in part, by the threat of legal action from rival Nasdaq. Nasdaq had been an outspoken critic of the exchange during the comment period process and despite the SEC vote, still remains quite vocal. In a recent news article, a spokesperson at Nasdaq said that it was “evaluating the SEC’s decision and assessing all options to ensure the best outcome for the US equity markets and all of its participants.”
In May, Amir Tayrani, an attorney for Nasdaq, filed a letter with the SEC that said the rules surrounding intentional time delays – such as IEX’s 350 microsecond delay – are not allowed under current rules. As such, the “Commission lacks the authority to approve IEX’s pending application and to treat IEX’s intentionally delayed quotations as protected.” Furthermore, should the SEC approve the application and treat delayed quotations as “protected,” a legal challenge to such an interpretation wouldn’t hold under legal scrutiny.
Greeley told Markets Media that he felt Nasdaq’s threats to sue weren’t just posturing.
“I’ve read the last letter that Nasdaq letting the SEC know that its re-interpretation of Rule NMS will be challenged,” he said.
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