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A year after becoming a full-fledged exchange platform, IEX Group Inc., still finds itself a maverick stock-trading venue attempting to disrupt an entrenched Wall Street system even as it has intensified the debate surrounding the nature of competition and stock pricing.
Run by CEO Brad Katsuyama, IEX garnered attention on the back of Michael Lewis’s 2014 book “Flash Boys,” which cast the firm as a virtuous player in an environment fraught with conflicts of interest and high-frequency traders, equipped with lightning-fast computers, seeking to ring up profits at the expense of average investors.
“’Flash Boys’ gave [IEX] a halo,” said James Angel, Georgetown University professor and an expert in stock exchanges. “But how long will that be a competitive advantage remains to be seen.”
Over the past 12 months, some markets experts have characterized Katsuyama and his exchange as struggling to become more than just a niche player in a world where stalwarts such as Bats, owned by CBOE Holdings Inc. CBOE, +0.29% the Nasdaq Inc. NDAQ, -1.42% and the New York Stock Exchange, owned by Intercontinental Exchange Inc., maintain a near-stranglehold on equity trading. Each of those three boast nearly 20% of daily exchange volume, compared with about 2.22% for IEX.
But IEX has grown comparatively quickly for a firm that didn’t exist a year ago, ranking among the world’s largest exchanges based on average notional, daily trading volume through July.
And despite its diminutive size relative to its peers and its newness in the landscape of trading, IEX has become one of the fiercest critics of practices that had been commonplace on Wall Street, including paying brokers to do business on exchanges. And although many are more familiar with the firm for its effort to combat ultrafast traders by slowing down trading on its venue, the company has taken on a much broader range of market-related issues where it sees inequities.
In a recent interview with MarketWatch, Katsuyama bristled at claims that the upstart exchange— which has entered the listing business—hasn’t made much of an impact since debuting early September last year.
“We don’t focus a lot on market share,” Katsuyama said. “The things that we have done to ensure the quality of [our platform] and that investors have the best experience run counter to growing market share…We are growing the right way, versus paying for order flow.”
His statement about order flow is a reference to Katsuyama’s biggest cause célèbre when it comes to security exchanges. The NYSE, Nasdaq and Bats paid about $2.7 billion in so-called rebates last year, according to company filings, which has become a bit of a flashpoint for industry players. Proponents argue that order-flow payments promote liquidity on Wall Street, while detractors say it is a blatant conflict of interest and undermines the concept of fair markets.
Under regulatory rules, the brokers are required to deliver the best price and the speediest trade — a concept known as best execution. Katsuyama and others argue that paying brokers to do business on one exchange versus another — offering what he describes as kickbacks—can pervert the process of equitable markets.
Katsuyama also said IEX’s growth, although not the ambitious 8% market share the firm had hoped for at this point, is still nothing to sneeze at in the context of global exchanges. And from a quality perspective, IEX isn’t doing so shabbily, at least by one measure: One of its own competitors, Bats, recently placed it tops among exchanges trading S&P 500 index-listed SPX, -1.12% securities based on the quality of trades — the same “best execution” concept as discussed above.
As for market structure — the rules that determine how the guts of the market function — IEX boosters say the company’s emergence on the scene has been a boon.
“IEX has come on to the scene and taken the debate and moved it forward,” said Joe Saluzzi, managing director of Themis Trading, one of the biggest critics of high-frequency trading, who helped write “Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence and Your Portfolio.”
Saluzzi said IEX has helped encourage debate around contentious practices including trading platforms offering rebates to brokers, ostensibly to make markets in certain securities, a form of payment for business known in trading circles as “maker taker.” The idea is to encourage liquidity across the market, proponents say.
However, the Securities and Exchange Commission is said to be considering the fairness of the maker-taker practice through a pilot program.
“Regarding equity market structure, an enormous amount of thought—at the Commission, in Congress, and in the private sector—has been devoted to this topic,” said SEC Chairman Jay Clayton in a July speech in front of the Economic Club of New York. “While there are certainly challenging issues that merit further consideration, it is time to shift the focus to action.”
Saluzzi speculates that IEX’s decision not to pay for rebates or for order flow that may, at the onset, limit its market share. “Some brokers say ‘I’d rather get paid because it goes in my pocket,’” he said.
There are more tangible signs of IEX’s effect on the industry. The NYSE debuted a speed bump on one of its platforms, NYSE American. A speed bump had been one of the signature features of IEX, intended to slow trading down to negate an advantage of speed enjoyed by superfast, computer-driven traders. Meanwhile, Bats shifted to a flat-fee model on one of its exchanges, EDGA, rather than offering maker-taker rebates.
“Imitation is the sincerest form of flattery,” Georgetown’s Angel said of IEX. “Clearly they have had an impact.”
Some of those new bells and whistles, however, may undercut IEX’s business. The exchange business is a “very competitive and cutthroat industry,” Angel said.
Still, Katsuyama is optimistic. “Essentially, we are building a different kind of exchange and we view what we do as different and validated by the people we have built it for,” he said. “If you look at the state of the market and the education of the broader stakeholders of the market between the time IEX launched and now to say that we haven’t made an impact is disingenuous.”
Editor’s note: An earlier version of this article indicated that IEX would be a venue for initial public offerings. However, the exchange at the moment is only focused on having companies switch their exchange venues to IEX.