When Michael Lewis published the Flash Boys in 2014, the story pitted Main Street investors against high frequency traders (HFT). Amongt those portrayed as the good guys was the Investors Exchange, later renamed to just the IEX. On the other side were HFT members who were taking advantage of high end equipment and technical understanding of how orders are routed to trade ahead of other investors.
As an alternative, the IEX was founded with a mission of leveling the playing field by implementing conditions in its trading engine to limit the benefits of HFT participants. Operating as a dark pool, the IEX benefited from the Flash Boys book, gaining interest from retail traders and brokers to connect to the platform. As a result, IEX market volumes have risen tenfold since 2014 to $158 million in average daily trading in January.
The success has led the IEX to file with the SEC to be classified as an exchange. However, that process has been met with friction by many of the so called HFT ‘flash boys’ who argue that the IEX’s benefits are overstated and in some cases what they are marketing isn’t true.
Citadel is attacking the very foundation of the IEX’s perceived value
Among those lobbying against the IEX this week has been Citadel. In a letter to the SEC, Citadel attacks the very foundation of the IEX’s perceived value: superior execution to retail investors.
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To prove its point, Citadel evaluated the volume weighted average market order execution as a relation to quoted prices, as market orders compose a key order type for retail investors. According to Citadel, execution statistics from Q4 2015 showed that market order executions on orders routed to the IEX were 135.7% of the spread compared to 59.27% with orders filled by wholesale market makers, which include Citadel Securities.
An IEX spokesperson commented to Finance Magnates: “Citadel’s fourth comment letter citing Markit’s study on IEX ignores 99.993% of all orders sent to IEX which represent 99.8% of all IEX volume. Their distorted use of this cherry-picked data highlights the need to improve transparency and disclosure to the investing public in our market, specifically with regard to 605 and 606 reporting, the basis for their study. The broad range of investor support that IEX has received throughout this process tells the real story about what we have built.”
As an example of the difference in execution, Citadel looked at a hypothetical stock with a $0.02 spread and price quote of 40.00×40.02. According to the report, marker order buys on the IEX would have an average execution price of $40.0236 versus $40.0159, or $7.70 more per 1000 share order. Overall, Citadel argued that if all market orders were sent to the IEX in 2015, investors would have been impacted by over $1 billion in execution slippage.
For its part, the IEX could counter that limit orders are more effective on its platform, and becoming an exchange would improve liquidity and average market executions. Another argument is that through its progress, it has raised awareness of execution risks to retail investors which could be leading more of them to use limit orders.
Regardless of any possible IEX response, Citadel’s execution report reveals that for the vast majority of the public, and often for regulators, understanding of trade executions is based on perceptions. In a similar vein, FXCM recently revealed execution figures to compare spreads available to their retail traders to those of the FX interbank market and FX futures traded on the CME.
FXCM CEO Drew Niv explained to Finance Magnates that the rationale behind their research was to dispel notions held by both retail traders and regulators that investors would be better served if FX trading took place on exchange based markets. Similarly, Citadel and others are finding themselves in a position that requires them to be proactive in defending their trading turf from what they believe are false perceptions.