New 'Flash Boys' exchange IEX

Wall Street's old guard is gearing up for a turf battle with upstart exchange operator IEX Group, which will launch its first trading for the public on Friday.

IEX, a leading critic of high-frequency trading and its embrace by the New York Stock Exchange and Nasdaq, plans a gradual ramp-up of its exchange, which it argues will allow individual investors to take back the market.

The exchange aims to slow down all trades with a physical delay that will prevent aggressive extreme-speed traders from cutting in ahead of earlier orders by others, distorting pricing.

Trading will begin in just two of some 8,000 possible companies Friday as IEX tests its systems, with the remaining companies integrated into exchange over the next two weeks, said IEX spokesman Gerald Lam.

- 'Speed bump' -

The launch is a landmark for four-year-old IEX, which was co-founded by former Wall Street trader Brad Katsuyama.

Katsuyama rose to fame with the 2014 publication of Michael Lewis's book "Flash Boys", which charged that high-frequency trading had rigged the system against small investors.

The former head of trading at RBC Capital Markets became suspicious when equity orders he commissioned came in partially-filled and at a higher price than he intended.

Eventually Katsuyama concluded the problem was widespread and the result of high-tech, lightning-speed automatic trading operations that had inserted themselves in the microseconds between the time that his trade was ordered and consummated.

The net effect was to force up the price paid by slightly slower investors.

"It just didn't feel right," Katsuyama told the news show "60 Minutes."

"It didn't feel right that people who are investing on behalf of pension funds and retirement funds are getting bait-and-switched every single day in the market."

The solution of IEX, which has been running a small, private "dark pool" exchange up until now, was to introduce a delay, or "speed bump" into the system designed to ensure that other market participants cannot intervene in transactions.

Under the system, an order is accepted to IEX's data center in Secaucus, New Jersey, and then traverses 38 miles (61 kilometers) of coiled fiber before being sent to the company's trading systems. The entire process takes 350 microseconds -- incredibly fast, yet relatively slow for high frequency traders.

"That's the only pathway into our exchange," said Lam. "If you look at all the other exchanges .... they're selling you real estate around their trading systems and ... if you want to be closer, you pay."

IEX currently has 192 subscribers who trade through its dark pool. Shifting to a public exchange will allow IEX to boost trading volumes and give it more influence in the broader market, Lam said.

- Potential disruptor -

The Securities and Exchange Commission approved the IEX application in June over the opposition of NYSE and Nasdaq, saying it would "promote competition and innovation."

Some around Wall Street view IEX as a curiosity for now, but with the potential to disrupt the broader system if it catches on.

"What IEX has done is try to level the playing field so that you don't have to have special access," said Art Hogan, chief market strategist at Wunderlich Securities.

"Will we see a revolutionary change overnight?" he asked. "No, like everything else on Wall Street, it's going to be an evolution."

IEX could be a catalyst for change but faces challenges overtaking larger rivals, said Morningstar analyst Michael Wong.

"If it turns out that IEX becomes a competitive threat and starts gaining material market share from the other exchanges, I think the other exchanges would be quick copiers," he said.

"The other exchanges definitely have the capital and technological systems and the current trading liquidity pool to give them a competitive advantage against IEX."

Indeed, Nasdaq plans to introduce a trading option that will protect investors' orders from being disrupted by high-speed traders, according to a Wall Street Journal report this week.

SourcE: AFP