When IEX introduced its speed bump (aka “the coil” or “the shoebox”) its purpose was to make it harder for high-frequency traders (HFT) to take advantage of calculating the NBBO faster than everyone else. In other words, if an HFT firm knows that a trading venue uses the SIP to calculate the midpoint, it can opportunistically route to that venue when it has a high probability of unwinding the position based on its faster view of the market. Coupled with IEX’s “shoebox” is a superfast ability to calculate the NBBO. That’s why the eventual admission that the legacy DirectEdge exchanges used the SIP, while its then-president claimed to use direct feeds, was a turning point for the industry.
The adoption of a speed bump by other trading venues was inevitable. It’s easy to implement, and the hype is too good to pass up. Canada was a natural next stop to adopt this since HFT has been sneaking across the border for years. And IEX is the logical extension of the router (and rhetoric) that Brad Katsuyama and Ronan Ryan built while at RBC. You can never go home again, but your ideas can.
Whoops! We Did it Again!
Our industry seems to have a knack for taking really good ideas and perversely twisting them (see “Maker-Taker”). This is no exception. The speed bump has now become a mechanism to do more than just negate latency arbitrage. When an Exchange sells co-location or direct data feeds to a customer, the expectation is that this speed advantage translates into more business from that customer. But sometimes this doesn’t work out. Maybe the customer isn’t that fast. Or has a crappy strategy and winds up blowing itself up in a few minutes. The advantage the Exchange is marketing depends too much on the abilities of its customers. Why not implement a more “guaranteed” advantage? Enter Alpha Exchange.
Alpha Exchange (owned by a bunch of banks by way of the TMX) has introduced a speed bump that is designed to make sure that strategies that provide liquidity (aka “post-only orders”) would have an advantage over any customer attempting to access those quotes. Most of these post-only orders would originate from…you guessed it…HFT firms. The Alpha Exchange speed bump gives HFTs time to see activity occurring in other venues and adjust its orders accordingly. Yes, this is what you think it is – guaranteed latency arbitrage!
The good news is that this was far too obvious a ploy for Canadian regulators to miss. The Alpha Exchange orders will not be covered in the Order Protection Rule, meaning that no one needs to route to Alpha when they are at the top of the book. Put more simply, they’re not the kind of Exchange that matters.
The Turtle Can Beat the Hare
So far, so clear. There are good speed bumps. There are bad speed bumps. Things get more interesting with Aequitas Neo. The Aequitas speed bump is only levied on immediate-or-cancel (IOC) orders sent by firms the Exchange identifies as HFT. Aequitas came up with its idea first and so it’s pretty clear that Alpha was designed to be the exact opposite.
The intent of the Aequitas speed bump is closer to that of the IEX “shoebox.” In fact, one could argue that the Aequitas speed bump is more effective in removing the HFT advantage. Because all orders are slowed down at IEX, the HFT firm can still have some advantage as long as it gets its order to the shoebox faster than other market participants. Aequitas only slows down HFT orders. It’s a speed bump that applies only to certain market participants under certain conditions.
When Aequitas applied for Exchange status, there were public comments that argued Aequitas should not be included in the Order Protection Rule (OPR) because of the discriminatory nature of the delay. How can you force a market participant to route to an Exchange when it knows its order will not be handled in the same way as other orders from other customers? Add insult to the injury, the HFT firms would also be charged higher fees! However, in November 2014, the regulator went ahead and approved the Exchange and its inclusion in the OPR.
A short nine months later, regulators are rethinking their position. On June 12, they issued a request for comment on whether an Exchange with any type of speed bump should be included in the OPR.
This got me thinking about the U.S. trade through rule and what it means to be an automated market center. The rule says that if a market has an intentional delay, it is considered a manual market and not included in the trade through rule. So then isn’t the IEX shoebox an intentional delay? It doesn’t seem possible that IEX would even attempt to gain Exchange approval unless it thought it would be considered an automated market.
My understanding is that IEX is making the argument that the “coil” is not an order processing delay but rather a moat that everyone has to cross before getting to the matching engine. Luckily, IEX provides the boat that crosses the moat, and it takes the same amount of time for everyone to cross. There is no delay in the order processing itself. This argument is bolstered by the fact that everyone has to cross the moat, not just HFT. There is simplicity to the IEX model that makes a story about fairness easier to understand.
The lesson is fairly obvious. Two wrongs don’t make a right. Treat everyone the same. Guaranteed advantages and explicit discrimination, even when deserved, only make markets more complex and obscure.
Simplicity is fairness.