Norges Bank Investment Management has sent a letter to the Securities and Exchange Commission supporting IEX Group, thestock-trading venue at the center of Michael Lewis’ book “Flash Boys.”
The Norwegian sovereign wealth fund which manages $824 billion in assets, is the latest financial firm to weigh on IEX’s application to become an exchange.
filed with the Securities and Exchange Commission in September to become a stock exchange. The application has divided Wall Street.
IEX tries to levels the playing field between hyperfast traders and ordinary traders using a 350-microsecond delay, or speed bump. Critics argue that this delay negatively impacts the wider market, and that the features are incompatible with exchange status.
In the letter to the SEC, Norges said that it has $288 billion invested in US-listed stocks, and that as a result it has a vested interest in having a regulatory environment that encourages a vibrant and heterogeneous investor community and is flexible enough to support new solutions.
It added (emphasis ours):
In our view, innovation by exchanges in recent years has focused overwhelmingly on latency reduction and on services such as novel order types that tend to benefit market participants with shorter return horizons. There has perhaps been insufficient focus on maintaining the centrality of exchanges to the market place for other types of investors.
Norges went on to say that trading firms manage the prices they quote on exchanges to control their risk, and that having faster connections to the exchange makes the process easier. It adds however that it also leads to smaller trades and more volatility than is required.
“We view this as a form of “rent extraction’,” Norges said. “As economic theory tells us, that represents a deadweight loss for the market overall.”
Here is the key passage (emphasis ours):
We would expect that the “speed bump” as well as other proposed features of IEX, such as the relative simplicity of available order types, would mitigate the potential for such rent extraction . The features should change the behaviour of market participants, including latency-sensitive liquidity providers. If indeed the “speed bump” makes IEX less attractive to such market participants, we would expect them to quote less aggressively on IEX than on other exchanges. We would therefore expect IEX quotes to be at the NBBO relatively less frequently than those of other exchanges, but possibly less fleeting and potentially with more depth . This may be a positive development quotes on IEX may be more indicative of true liquidity availability than those on other exchanges, which have been described as “phantom liquidity” .
To recap, the NBBO is the national best bid or offer, and SEC regulations require brokers to guarantee this price to their customers. So Norges is saying that while IEX won’t always have the best bid or offer, its quotes are less likely to disappear in a split-second.
Brad Katsuyama, chief executive of IEX, told Business Insider that the Norges letter makes clear that the IEX structure does not give it an unfair advantage, as some have argued.
“IEX trades only on behalf of clients, and only to predatory strategies and the incumbent exchanges does it seem “unfair” that we have built technology that protects orders rather than exposing them.”
He added that the investors now sending letters of support for the application are the reason he and his team started IEX.
“A number of them encouraged me and the team to take a leap of faith, and now that sides are being taken, we appreciate those who have stepped forward to support us,” he said.
Asked if any of the responses had been surprising, he said a few of the letters explicitly described latency arbitrage, a trading strategy which seeks to take advantage of differences in the speed of price quotes at exchanges.
“Naysayers have gone from denying it exists, to explaining it in detail and calling IEX unfair for preventing it,” he said.
The Norges letter is the latest addition to a debate around the IEX application that has at times turned ugly.
IEX was likened to the “non-fat yogurt” shop on Seinfeld by the New York Stock Exchange. IEX responded by taking a swipe at NYSE, describing feedback from NYSE as “disingenuous,” “categorically wrong,” “ironic,” and “unfounded.”
IEX later sent a sent to investors seeking their support for its application, with an anonymous market participant in turn posting the letter on an industry forum with critical comments.
Even Michael Lewis, the author of the book which first brought widespread attention to IEX, has gotten involved,
filing a letter to the SEC supporting the application.
There have been so many comment letters responding to the IEX application that the SEC has asked for 90 more days to decide whether the application should be accepted.
Katsuyama told Business Insider that he isn’t surprised the IEX application has become such a heated debate.
“Given the money that is at stake, we expected opposition from exactly the groups trying to block us right now: select high-speed traders and the exchanges who enable them.”