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Investment Management

Will IEX Level Playing Field for Treasurers?

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June 28, 2016

IEX’s SEC approval bodes well for corporate stock buybacks.

Distributed ledgerShare repurchases are still a major component of companies’ capital allocation strategies, and soon they may become less costly. That’s because the Securities and Exchange Commission recent approved IEX as an exchange June 17, which is likely a major disappointment for the high frequency trading (HFT) community as well as the exchanges and technology vendors that cater to them.

IEX is currently one of more than 35 so-called dark pools, which execute orders without displaying quotes. When it starts operating as an exchange, likely in August, IEX’s quotes will be “lit,” and more importantly they’ll be protected under Regulation National Market Structure (NMS), which means when IEX has the best bid or offer, orders must be executed there.

HFTs and much of the electronic trading industry submitted comments to the SEC denouncing the exchange’s application of IEX, which was featured in Michael Lewis’s best-selling book, Flash Boys: A Wall Street Revolt. Joseph Saluzzi, a partner at Themis Trading, said that the 350-microsecond delay IEX imposes on quotes is likely to eliminate the advantage HFTs and other high-speed trading firms capture by using costly quote feeds offered directly by the exchanges instead of the slower consolidated SIP feed available to the rest of the market. “If they lose that advantage, it becomes a more attractive place for institutions to trade size, and the predatory style of trading could migrate somewhere else,” Mr. Saluzzi said.

That’s potentially a big deal for corporate treasuries, since their buyback programs are huge, ongoing purchases of stock and are subject to strict rules that essentially act as “tells” and make the orders relatively easy to spot, despite their brokers’ use of algorithms and other strategies to hide large trades. Since opportunistic traders aim to trade ahead of large orders, driving up the price, their disappearance should reduce the price of buying back stock.

Mr. Saluzzi said that even if the new exchange’s market share increases little from its nearly 2% today, it’s likely to disrupt HFTs trading strategies. That’s because the delay makes it impossible for their algorithms to know where the quote on IEX is, and whether it is providing the best bid or offer at which Reg NMS requires executing the trade.

“So even if it’s a very small part of the stock-execution business, it could be enough to throw a wrench into the model that’s been built over the last 10 or so years to take advantage of everyone else,” Mr. Saluzzi said.

He added that as an exchange providing a lit quote, IEX is likely to see its execution volume increase, and capturing 10% of market share is not unlikely. Trades are already larger on IEX operating as a dark pool, and as a lit exchange, Mr. Saluzzi said, the bid-offer spread is likely to widen, allowing for still larger trades.

“We may start to see a 1000-share bid,” he said. “That means real liquidity could come back to the market, instead of the ‘noise’ (small bids and offers) now that disappears on the screen.”

Even if the delay does not disrupt the stock market as many think it will, IEX provides others advantages to corporates and others seeking to execute large trades. For one, it doesn’t permit collocation, in which a high-speed trading firm locates its server close to the exchanges in order to capture their quote data nanoseconds ahead of other market participants.

“So the potential leaking of information may not be as great compared to other exchanges, whose data feeds are sending out every detail of a market participant’s order type,” Mr. Saluzzi said. In addition, IEX doesn’t provide rebates for posting orders on the trading venue, drawing market participants who are less price sensitive and willing to pay a bit extra to executive larger trades without the interference of high-speed, opportunistic traders.

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