At a special evening event in the London Stock Exchange before Christmas, IEX President Ronan Ryan joined Insight for a wide-ranging fireside chat on the future of trading. He also opened up about his appearance in Michael Lewis’ bestselling book, Flash Boys. Below are a few excerpts from his talk.
On seeing a copy of Flash Boys for the first time
People were calling me and saying, ‘chapter three in the book is called Ronan’s Problem’. I got the book and I went right to chapter three, of course.
But the first quote, the first thing that Michael Lewis wrote about, is this: ‘Part of Ronan’s problem was that he didn’t look like a Wall Street trader. He had pale skin and narrow, stooped shoulders, and the uneasy caution of a young man who has survived one potato famine and is expecting another.’ All right! Can you imagine that being the first line?
On his early experience of high frequency trading
We went out and we met with a bunch of buy side firms. We sat there, and we watched them trade…and the exact same thing was happening. You try and buy 10,000 shares, and you would only get like 4,000 or 5,000 of it. They called it ‘fading liquidity’.
We set out to figure out what was going on, why was it disappearing…All 13 exchanges were in New Jersey, and all 13 of them were in four buildings in New Jersey. When you are spraying out orders to New Jersey, we found that you are arriving at the data centres at different times, and arriving at the data centres at different times allowed someone to see a big trade (nothing illegal) make a computational guess that it was an institutional order, and race to the next venue.
Let us just say the easiest example of this is there are 100,000 shares to buy. 25,000 shares on the New York Stock Exchange, 25,000 on Nasdaq, 25,000 on Bats, and 25,000 on Direct Edge (Direct Edge and Bats are now owned by CBOE, but bear with me). What a broker’s router does is send out orders to those four data centres to try and lift the 25,000 shares at each venue. We noticed that we would always get everything we saw at the first venue, but by the time we got to the last venue, we get nothing. And the time difference between arriving at the first venue and the last venue was only two milliseconds, 2/1,000ths of a second.
We came up with this idea, which is intuitive now, we said: ‘Why don’t we slow down our fastest route and try and arrive at all four data centres near simultaneously?’ You have to understand in equity market structure, every network engineer is trying to make things as fast as humanly possible. I had to go and talk to the network engineers, because I used to work in that business, that is what I did after college. I said: ‘Listen mate, you know this fast circuit? I need you to slow it down.’ They thought we were crazy, but we slowed down everything to arrive as near simultaneous as we could. In any case, we were able to buy and sell everything that we saw in the screen.
We did not want to be the institutional trader’s ‘signal factory’. Whereby people could co-locate right next to us, see these big trades and, within the parameters of regulation, make a guess that this is a big trader entering the market and try and get the liquidity ahead of them on other markets.
On setting up IEX
Our original business plan was, ‘okay, if we are great at building routers, why don’t we build a router and then tell the buy side to tell their brokers to use our router for everything?’
Then we came up with the idea, ‘Well, the centre of the ecosystem where a lot of these issues reside, are the exchanges themselves. Why don’t we build an exchange and fix it from that vantage point?’ That is kind of how IEX came about and obviously if people have read the book, you kind of know the story of what we do.
What we said is, ‘we are going to put a speed bump around our market.’ What we do is we literally delay every single order that comes into our market by 350 millionths of a second, so 350 microseconds. The way in which we do it is we coil cable in a box, and in the US we speak in miles, so it is like, 38 miles. Basically we coiled 61.235 kilometres of fibre optic cable in a box. Every single trade that comes into our exchange, literally comes in and goes through these; they look like three big fishing spools.
Every trade into our platform, coil delayed, happens almost immediately. If the buyer and seller are there, we will match it in about 80 microseconds, so we are not slow. We are not anti-technology.
The key part is, we delay the acknowledgement of the trade. The trade, after it is consumed, after it matches up, we send it out over the speed bump again. All that means is that the earliest you can find out that a trade occurred in IEX is a minimum of 350 microseconds after that happened, 350 millionths of a second.
On the US order protection rule
The US has the Order Protection Rule. If you are going to match as a venue or an exchange, if you are a dark pool or if you are a broker, the only way in which you can know what the fairest price in the market is, is to subscribe to all these market data feeds and you can say, ‘okay, currently the best bid is $10. It is on BATS. The best offer is $10.02. It is on the New York Stock Exchange.’ I have to print this trade between $10 and $10.02.
If you do not respect the BATS quote, and you missed that they had the bid price at $10, and instead sell at $9.99, that is called trading through. If you trade through a better quote than the client could have received in the market, you could get a fine from the regulators. It is a serious offence, but you have no choice.
In the UK or Europe, what I like is – and what a lot of the buy side institutions like – they will say, ‘look, if I want to buy 5,000 shares and I see 5,000 shares on the LSE for $10.01, and I see 100 shares on BATS for $9.99, technically I could buy 100 shares of the 5,000 for a penny cheaper’. In the US, you have to send your order to the $9.99 first and then hope that when you send your shares to the LSE, that it has not faded. Whereas here, you can go, ‘I want to buy 5,000 shares. The LSE is willing to sell to me for $10.01,’ and you can just go there. There is no Order Protection Rule in Europe.
Do I think the order protection rule should go away?…It is something I wrestle with. I could not give you an answer if it should go away, but these are the sort of challenges that exist in the market.
In any case, the debate in the US right now is really, really hot on what is fair and reasonable. We are the only exchange that does not charge for anything other than when you trade on the exchange. What we will likely do in the near future is make public what it costs an exchange to provide market data.
On the MiFID II unbundling regime
I think it is a positive step. Look, I am sure, for brokers, it has been a massive pain. There is loss of revenue, I get all of that. However, I just think that the research costs being levied on the end investor is not the right way to do it. Now, when brokers have dropped their research pricing, like ten times cheaper than it was before, I as an investor will be asking, ‘Well, why were we paying a million last year and you are only paying 100,000? Were you buying research through your trading volume that you did not even use?’ The answer is, unequivocally, yes.
Now, there is more scrutiny on what you buy and why you buy it. I think that is a good thing. However, just looking at it from a best execution standpoint, and I do not mean to be insensitive to people who have lost money from brokerage on the research, but if people are sending orders to a broker simply because they have to meet X number of shares to pay this broker for research, that is not how anyone should want their brokers handling their orders. You should not be routing your client’s orders for your own financial benefits so that you do not have to pay for research. I think that is a very, very sensical argument and that is why we are supportive of it.
I will tell you, in the US, we have a lot of big buy side clients who are institutional firms, and they have already started to unbundle in the US.
I understand MiFID also adds a higher degree of scrutiny on the stability of the markets. I do not know who could argue against that in an environment where everything is run by technology and in an environment where you have all of these InfoSec concerns. Having the markets on which you trade be required to be more stable is, I think, from a technological standpoint, a fantastic advancement.
On the future of trading
I think that it is what is going on in the US, and I am sure over here, is that people are just trying to get faster and faster and faster. But you are never going to be faster than the fastest. We [IEX] have done analysis on when a quote changes. We did analysis on one millisecond of time in a Microsoft quote on Nasdaq, and it takes us about an hour to go through what happens in the millisecond, but the cheat sheet version of it is this. When a new quote is set, the bid is 10 and it jumps to 10.01, the people who joined that queue who set the inside at 10.01, if you are not there in under like 40 microseconds, you are way behind.
You will see these people, new quote, 40 microseconds then about 100 microseconds later, you will see the second tier market makers, high-frequency clients, and then literally, two to five milliseconds later, in come the broker algos. It is just so foreseeable when you see the people at the front of the queue cancel their quotes, the guys who came in at 100 microseconds all cancel their quotes, and then these guys who came in milliseconds later, just get a wave of smack downs on them and they get rolled over. It is not a battle you want to be in and that is why we are big believers in having the exchange which is the centre of the ecosystem be the referee.
I think the answer is technology in every industry has made things more efficient and I would be lying if I did not say here in the last 15 years the markets have got more efficient. But usually the utility curve is like this [upward] on all industries with technology, and I think in our industry, it is a little bit down here [downward]. That little delta between where it could be and where it currently is, that is the part that needs to be bridged and fixed. I think technology can do that. It is just a different view on technology, and our whole tenet on this is, it is not that high-frequency are bad. There are technological inefficiencies in the market and we use technology to solve them.
This is an edited transcript of an Insight event on 5 December 2018. Our sincere thanks go to Ronan Ryan and IEX for their support. If you would like to be notified of future events, you can subscribe to our mailing list, or follow us on Twitter at @fcainsight.
