I get schooled on the IEX debate…
A respected industry insider pointed out to me last night that there are two problems with my IEX coverage. The first is that people think I am obsessed with IEX and give them no credit. As he pointed out, they have earned much of their accolades by creating an innovative dark pool that protects investors from stale prices and advancing the education of many investors of the dangers of badly designed routing technology. What is interesting is that I agree with that, and actually have given them a lot of credit for that and for changing the dark pool narrative as well. Before IEX burst onto the scene, there were calls in Congress to “bring more trading into the light” and the popular view of dark trading was that it was likely something nefarious. Now, however, in large part due to IEX’s efforts, it is acceptable for institutions to use dark pools to contain information leakage. (Editors note — This is one reason I supported IEX’s Exchange Application and their calls for simplicity in market data distribution)
The second problem that he pointed out, is that my deconstruction of IEXs narrative doesn’t “hit people in the gut,” while IEX’s CEO is an expert in crafting emotional appeals to the average person. He called my analysis “hyper logical”, and said that while most traders, quants and industry insiders know IEX uses out of context facts and emotion charged words to sustain its momentum, the average person doesn’t. As a result, the Congress supports IEX and mainstream media outlets don’t want to criticize them… yet.
So, when I saw this morning that several people and newsletters had “shared” IEX’s latest emotionally charged video, I realized that I needed to answer its rhetoric. Yesterday, I commented on this video to counter its main thrust; that rebates should be banned. While I pointed out that banning rebates is in IEXs self-interest, but risks harming American competitiveness by reducing liquidity, I didn’t bother debunking the rest of the narrative, so, here goes:
Brad Katsuyama does his best “Dennis Moore” impression…
In one of my favorite Monty Python skits, “Dennis Moore”, the masked highwayman robs the rich to give to the poor so often, that by the end of the clip, he is robbing the (formerly rich) poor to give to the (formerly poor) rich…. In a similar vein, IEX, has been propelled based on their popularity from cash-strapped, underdog heroes of a best-selling novel, to a well-funded, profitable, high profile corporation, with flashy offices and enough capital to fund venture investments and hire a large analyst team. While I do not begrudge them their success (really), they continue to cash in on the well-worn “underdog” narrative to produce marketing and policy advocacy pieces missing relevant facts, containing no disclaimers, and with emotive language targeting the uninformed. This behavior, as exemplified by the recent video with MarketWatch, risks harming both their own clients AND the capital markets in general. The latest video starts with sound bites about the amount of computerized trading, makes vague claims about flash crashes to spark worry and concludes with IEX’s self-interested call for banning exchanges from providing liquidity incentives to their customers. Let’s dig into the video:
It starts with a scary claim about “flash crashes” without any specific rationale other than the fact that 50-60% of trading is automated. This is another attempt to capitalize on people’s irrational fear of computers, and he predictably glosses over the improvements made to the market in the past 7 years. In an ironic twist, if one were to look at the exchange order types, the likely “winner” of the “most likely passive order type to contribute to a flash crash” category, would be IEX’s new crumbling quote order. That order is designed to move client orders out of the way when the market is falling… (NOTE — I do not think that their order type or any exchange order type contributes to flash crash risks directly. I am just pointing out that IF any order types could do so, that their own is high on that list.)
The next false claim made is an assertion that, because, such a high percentage of volume comes from high frequency trading, that the liquidity in the equity markets is not “real.” This is an old meme, that doesn’t pass any common-sense truth test. In my 30+ years in the markets, every trading cost model I have ever seen (including those that I have built), and almost every institutional buy-side trader I have ever interacted with, uses a stock’s average daily volume as a vital input to estimating trading cost or determining how large an order to place. While it is likely true that there are differences in types of volume (particularly during times of stress), it is extremely rare to find any traders who discount the volume traded in the U.S. based on the notion of fake volume.
The main problem in the video, however, is, as I pointed out yesterday, that IEX has a conflict of interest on the issue of rebates and they seem willing to hurt the integrity of the market to pursue that interest. Rather than call for better disclosures to manage the conflict, they call for the ban of a practice that only has a conflict of interest for half of the participants that use it. Their motive is quite transparent, however, since they would prefer that the government stop their competitors from providing the liquidity incentives that they have chosen to eschew…
Timely Expose of Misused Statistics
An excellent piece in Forbes describes a key problem in today’s media prevalent in the current (oxymoronic) “Information Age.” It describes the danger of misused and out-of-context statistics or studies to influence public opinion. From the perspective of the financial services industry, this is especially troubling. We have, for the most part, been trained to include disclaimers and compliance reviews for any communications that make predictions or use data to advance our firm’s self-interest. Further, we have become accustomed to fierce competition to quell outliers that make false or misleading claims. Hmmm. Does this sound familiar to any of my readers??? Well, my take on this is that there is a clear outlier in our industry, who continues to produce misleading fan fiction to promote an agenda to feed their own profit…. I wonder when either the financial press or the regulators will see the danger of this going unchecked, and start reporting / investigating.