'Flash Boys' Challenger IEX Struggles in Quest to Transform Trading

FT Trading Room Equity exchanges ‘Flash Boys’ challenger IEX struggles in quest to transform trading

Exchange accounts for 3 of every 100 stocks traded in the US despite initial excitement

Brad Katsuyama is pushing into other revenue-generating areas © Bloomberg

Richard Henderson in New York JUNE 9 2019

Brad Katsuyama was once a low-key Wall Street trader shuffling between Manhattan skyscrapers in a fleece vest. But five years ago, he was thrust into the spotlight as a hero, shielding ordinary investors from the high-tech excesses of Wall Street.

The narrative, captured in Flash Boys, the 2014 Michael Lewis bestseller, recast high- frequency trading — where investors deploy ever-faster cabling and supercharged computers to nudge ahead of rivals — from an arcane topic debated at industry conferences into a real and urgent threat to the integrity of financial markets. The publicity helped propel Mr Katsuyama’s Investors Exchange from a private share platform into one of 13 fully-fledged exchanges.

But the excitement has faded. Today, three years after gaining regulatory approval to run a national securities exchange, IEX accounts for just three of every 100 stocks traded in the US. The New York Stock Exchange, Nasdaq, and CBOE Global Markets, which continue to offer inducements to high-frequency traders (HFTs) to attract orders, together account for 60 per cent. To some, it is a missed opportunity: a sign that the structures IEX hoped to dismantle have remained in place. The incumbent groups have retained their hegemony and HFTs still threaten to pick off the best prices from slower investors.

“I’m surprised [IEX’s] market share isn’t higher,” said Kevin Cronin, global head of trading for Invesco, the $955bn-in-assets firm based in Atlanta, who tried to hire Mr Katsuyama before he launched the exchange. “They have achieved a lot — but there’s a long way to go for IEX to achieve what many thought they would have.”

Mr Katsuyama accepts that IEX’s key innovation to thwart HFTs — a “speed bump” made up of 60km of spooled fibreoptic cable that physically slows electronic messages — has not transformed the business of stock trading. And he notes that exchanges such as NYSE and Nasdaq continue to attract huge volumes by offering fee rebates to their best customers, which are often HFTs.

“One of the things we underestimated was how much the industry revolved around exchanges paying for order flow,” said Mr Katsuyama. “People want us to fail. I think from that perspective we’re really proud of where we are but there’s a lot more to do.”

His big hope is that a regulatory programme to assess the impact of fee rebates will prove they benefit exchanges rather than investors, which could burnish IEX’s appeal. The pilot programme was put on hold after the leading US exchanges sued the Securities and Exchange Commission, a rare move.

Meanwhile, he is pushing into other revenue-generating areas. Three years ago IEX announced it would begin to list companies, cracking a duopoly shared by NYSE and Nasdaq. IEX does not compete for the glitzy business of initial public offerings but instead targets companies considering a switch from the two exchanges by offering lower listing fees.

According to an IEX fundraising document from its early years, the exchange aimed to lure more than 250 companies to transfer their listings. But so far it has just one: Interactive Brokers, an electronic trading outfit, which moved from Nasdaq last year on the grounds that investors would receive “better execution prices”. Wynn Resorts, the Las Vegas hotel chain, dropped plans to switch its listing after Steve Wynn, the founder and vocal supporter of IEX, left in the wake of sexual harassment allegations.

“This is a tipping-point year for IEX,” said Mehmet Kinak, global head of systematic trading and market structure for Baltimore-based T Rowe Price, the $1.1tn-in-assets manager. “If they can get more listings — and it only takes a few — that will make a big difference. But if it doesn’t happen, it will get harder.” The company faces new threats. An upstart stock exchange backed by Citadel Securities and Virtu, two brokers that have profited from the switch to faster trading, is set to apply for regulatory approval and could dent IEX’s market share.

IEX is also locked in a tussle over market data. The company offers its own information for free and describes the practice of stock exchanges charging for data as a “multibillion-dollar shakedown”. In May, IEX claimed the dominant exchanges charge up to 1,500 per cent times the cost of producing the data they sell, when compared with its own data costs.

By pressing exchanges and regulators on market data and exchange rebates, IEX believed it would continue to draw trading from larger exchange groups, said Ronan Ryan, a co-founder and president of the company, who also features in Flash Boys.

Last year Variety reported that Netflix is planning to make the book into a film, joining other Michael Lewis screen adaptations such as The Big Short and Moneyball.

“Love us or hate us, you can’t argue IEX has not advocated for the institutional investor,” Mr Ryan said. “Everything is designed on that and I’ll take that to my grave.”