On June 18, the U.S. Securities and Exchange Commission granted IEX Group, Inc., aka. The Investor’s Exchange, run by ex-Royal Bank of Canada trader Brad Katsuyama, approval to become a national securities exchange, placing it in direct competition with the 12 other national public stock exchanges in the United States.
During the lead-up to IEX’s eventual SEC approval, in February, Jeffrey Sprecher, CEO of competitor Intercontinental Exchange Inc. (ICE), called IEX “un-American”.
Well, yeah, it’s Canadian.
IEX began as an alternative private securities trading system, or “dark pool”, in October 2013.
IEX’s initial filing with the SEC took place last September, and was delayed twice, in December and then again in March, with the final announcement of approval arriving on a Friday in the middle of June, after the markets had closed.
The IEX approval marks the first new standalone equities exchange to be approved by the SEC since 2010.
IEX currently accounts for 1.6% of all equities trading in the U.S., meaning that their underdog status remains secure.
In the past, however, Katsuyama set a target that IEX aspires to account for as much as 8% traffic withing two years of launch, and is now setting out to increase its volume and convince investors that the exchange is a better bet for longer-term, more stable returns.
Approving IEX as a standalone exchange, SEC Chair Mary Jo White said, “Today’s actions promote competition and innovation, which our equity markets depend on to continue to deliver robust, efficient service to both retail and institutional investors.”
The SEC added that it will release a report within two years, assessing the effects of any intentional access delays on market quality.
Brad Katsuyama, began working as a stockbroker for the Royal Bank of Canada in Manhattan in 2002, aged 24, a year after graduating from Laurier University’s Business and Economics program.
Eventually becoming RBC’s Global Head of Electronic Sales and Trading, making investments for Canadian pension funds and whatnot, Katsuyama opened his own stock brokerage in 2012, called IEX, using the “speed bump” technology that he’d developed at RBC, nicknamed Thor, with the bank’s blessing.
A patent for the Thor technology, the “Synchronized Processing of Data by Networked Computing Systems”, was approved in the U.S. in 2013.
Katsuyama came to fame after being featured in the 2014 Michael Lewis best-seller “Flash Boys”, which contended that the stock market is rigged by high-frequency traders who front run orders from unsuspecting dupes, who would unsuspectingly purchase a bundle of stocks at a certain price only to find that the order was only partially available, while the price for the remainder had gone up.
“Slower, in many ways, allows for people to feel safer and provides protection. And I think that’s the way to get long-term liquidity back into the market. Don’t use them as prey, protect them.” – IEX CEO Brad Katsuyama
This practice of high-frequency trading (HFT) came to prominence in 1999, enabling several large investment banks, hedge funds, and other institutional investors to buy stocks microseconds before other buyers, eventually earning profits in the billions selling the shares on at a higher price.
“Flash Boys” has since been optioned by Sony to be potentially turned into a Hollywood film, following in the footsteps of other books by Lewis, such as “The Big Short, “The Blind Side” and “Moneyball”.
For several years before “Flash Boys” made him famous, though, Katsuyama worked out of a windowless 200 square foot office in midtown Manhattan, struggling to pay salaries and attract start-up funding.
Katsuyama’s innovation with Thor was to create a “speed bump”, whereby trades are slowed down by 350 microseconds, just enough delay to prevent HFT, thereby allowing buyers through IEX enough time to make a purchase without fear that they were being outdone by some investment bank’s computer.
Katsuyama and his team accomplished this using 38 miles of fibre optic cable stored in a compartment approximately the size of a shoe box.
By the time Michael Lewis began looking into exposing HFT as a rigged system that enriches a few large players while screwing over smaller investors, IEX was naturally positioned to play the “ragtag, fugitive fleet” role in a battle against Wall Street, perfect fodder for an eventual Hollywood film.
With the success of the book, Katsuyama now employs over 70 people working out of a 44th-floor office at 4 World Trade Center, and ended up raising $75 million from investors.
Wall Street mostly hates IEX and Katsuyama, and the alternative exchange faced plenty of pushback in the run-up to its being approved by the SEC this month.
During the public-comments period of IEX’s filing, both the New York Stock Exchange and the Citadel hedge fund spoke against IEX’s approval, the Nasdaq threatened a lawsuit against the SEC if approval went ahead, and the BATS Global Markets exchange argued that high-frequency traders would inevitably figure out a way to defeat IEX’s speed bump.
“We just think this would be bad for the markets, it’s unfair, and it doesn’t belong as a public exchange,” said head of Citadel Execution Services at Citadel Securities, Jamil Nazarali, speaking during a panel discussion on equity market structure at a Sandler O’Neill conference in June.
“It is looking for the ability to have a regulated monopoly status that the other exchanges do not have. It is un-American and it is not fair.” – ICE CEO Jeffrey Sprecher
The Nasdaq issued a terse statement immediately after IEX’s approval, writing, “We are evaluating the SEC’s decision and assessing all options to ensure the best outcome for the U.S. equity markets and all of its participants.”
And lots of Wall Street heavy hitters denounced the company, as “un-American” no less, in the media.
“It is looking for the ability to have a regulated monopoly status that the other exchanges do not have,” said ICE CEO Jeffrey Sprecher. “It is un-American and it is not fair.”
Katsuyama responded to Sprecher’s “un-American” comment, writing in an email to Reuters, “It’s ironic that the supposed centerpiece of American free-market capitalism is using behind-the-scenes political pull to obstruct a new entrant from competing,” adding that ICE buys patents and intellectual property “at an alarming rate.”
Wall Street incumbents aren’t pleased about Katsuyama’s IEX approval because it threatens to level out the two-speed market that’s been created since the advent of high-frequency trading.
“Long-term liquidity is missing in the markets, which actually creates a lot of volatility,” said Katsuyama to Marketplace. “High-speed data, high-speed technology — these are all things that the exchanges are selling. It creates short-term incentives. But when the market’s volatile, you can’t pay someone enough to stand in front of a volatile market. And when they pull out, the long-term investors have migrated to off-exchange platforms, like dark pools, etc. Nobody’s left.”
The Investors Exchange is an attempt to create a more fairly regulated stock market that uses intentional delays to ensure simultaneous order arrival, so that customers are protected from predatory buyers employing technology that regular buyers don’t have access to.
“What we’re trying to do with IEX is bring long-term investors back into the public markets to create a more robust market,” said Katsuyama. “It’s funny, the opposition was spreading all sorts of misinformation about, ‘Oh, IEX is gonna harm market quality.’ In this case, slower, in many ways, allows for people to feel safer and provides protection. And I think that’s the way to get long-term liquidity back into the market. Don’t use them as prey, protect them.”
IEX recently turned a corner, and has been profitable for a year prior to the SEC approval.
It expects to start operating as an exchange on August 19, and to implement stock symbols on September 2, ceasing operations as IEX Alternative Trading System (ATS).
The company has already rolled out its IEX mobile app for iOS and Anroid.
Witness the moment that Brad Katsuyama informed his staff that IEX had been granted SEC approval in the video below.
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