The natural trend in technology is to speed things up. The implementation of a new type of platform or solution usually means quicker, more efficient processes. This theme is particularly evident in the equity markets, where the speed of market data and trade execution are both fast approaching light speed.

But that changed on June 17, 2016, when the Investors Exchange (IEX) and its 350-microsecond delay gained regulatory approval as a national securities exchange from the US Securities and Exchange Commission (SEC). In doing so, the Commission did more than just add an exchange—it took a stance on intentional access delays. In a release announcing IEX’s approval, the SEC said delay mechanisms less than one millisecond are immaterial, and “will not prevent investors from accessing stock prices in a fair and efficient manner consistent with the goals of the Order Protection Rule,” which falls under Regulation National Market System (Reg NMS) and “protects the best-priced automated quotations of certain trading centers by generally obligating other trading centers to honor those protected quotations and not execute trades at inferior prices.” 

While the SEC deemed the impact of IEX’s speed bump on the Order Protection Rule to not be substantial, the same could not be said for its effect on some of the other exchanges, which considered the new interpretation of the ruling a chance to reevaluate their offerings.

Less than a year later, three exchange groups have submitted proposals to the SEC pertaining to integrating speed bumps or order types that function in a similar way. Nasdaq and the Chicago Stock Exchange (CHX) are both currently awaiting regulatory approval from the SEC for proposals that, to varying degrees, mirror what IEX introduced less than a year ago, while NYSE Group received SEC approval for its own delay mechanism on May 16, as Inside Data Management went to press.

“There has always been an arms race amongst exchanges. A proliferation of what one person does another person does it in a different fashion,” says Rich Vigsnes, global head of equity trading for Northern Trust Asset Management. “Once the SEC came out and said, ‘Look, anything less than one millisecond is de minimis,’ it just opened up the frontier for any type of speed bump.”

It remains unclear whether the SEC’s decision to grant IEX status as a national exchange was knowingly opening a Pandora’s Box—exposing the industry to complexity issues due to an eventual proliferation of speed bumps—or merely the Commission’s way of ushering the US equities market into a new era where speed isn’t necessarily king. But it’s clear that regardless of what’s inside the proverbial box—and despite their previous positions on the issue—other exchanges are now interested in looking inside.

“The SEC has changed the definition of what they consider immediate,” says Tal Cohen, senior vice president of North American equities at Nasdaq. “So we thought, ‘Why don’t we rethink how we can innovate and serve our customers in this new environment?’”

Same Model

Of the three proposals, NYSE’s filing most closely mirrors IEX’s current model. The exchange is looking to implement a 350-microsecond delay for orders on NYSE American (currently known as NYSE MKT), the exchange operator’s venue for small- to mid-cap stocks. The two proposals are so similar that NYSE cited IEX 61 times in its 15-page filing submitted to the SEC on Feb. 9.

This was deliberate, says Michael Blaugrund, NYSE’s head of equities, as the SEC has already set the bar for what is considered an approved speed bump, and implementing one extremely similar to what’s already in place should make the proposal non-controversial.

However, there are some differences between how the two speed bumps operate—NYSE’s delay is software-based, while IEX’s is implemented through hardware; the two exchanges have different ways of routing orders through their speed bumps. Blaugrund maintains these are immaterial, though John Ramsay, IEX’s chief market policy officer, disagrees, saying both these differences are substantial and need to be addressed. He also points to NYSE’s lack of explanation in its proposal around why the exchange group wants to implement a delay, especially since NYSE strongly opposed IEX’s approval as a national exchange.

Blaugrund, however, says the SEC’s approval of IEX means NYSE should be offered the same opportunity to implement a speed bump of its own if it puts forth a similar proposal.

“We certainly opposed this development, and felt like the SEC should have taken another path. But given that this is the new state of play, we are going to offer customers the alternatives that they are interested in,” Blaugrund says. “Our obligation is to demonstrate that our proposal is consistent with the Exchange Act. Given that we are proposing a model identical to one that the Commission has already determined to be consistent with the Exchange Act, we think it should be self-evident.”

Different Strokes

CHX’s proposed speed bump differs from IEX in that it is discriminatory. Originally entitled Liquidity Taking Access Delay (LTAD) and filed in September 2016, the Chicago-based exchange resubmitted the proposal on Feb. 14 under a new name, Liquidity Enhancing Access Delay (LEAD).

Instead of applying a delay to only liquidity-taking orders, which was the case with LTAD, LEAD will be applied to all order types with the exception of liquidity-providing orders and cancel messages for resting orders submitted by LEAD Market Makers (LEAD MMs) who meet heightened market-quality requirements. The change was made in response to comment letters questioning whether LTAD would potentially allow firms to “quote bait” or facilitate non-bona fide trading liquidity strategies, says CHX associate general counsel A.J. Kim.

“We introduced these new performance standards, which we believe are as aggressive as—if not more aggressive than—any requirement in the National Market System for market-makers. We believe these standards will ensure that the quotes displayed at CHX will remain reliable and accessible,” Kim says. “We decided to propose the most aggressive requirements possible that would not negatively impact the ability of most market-makers to participate in the program.”

Nasdaq’s Extended Life Order (ELO) is the most dissimilar from IEX of the trio of proposals, being an order type rather than a speed bump (Nasdaq, like NYSE, was critical of IEX’s application to become a national exchange). ELOs, which were initially announced last August and are only available for retail orders, are granted priority in the queue over resting displayed orders as long as the order is not altered or canceled by the member for a minimum resting time of at least one second. 

As with the other proposals, Nasdaq’s ELO has faced criticism via comment letters. The main gripe stems from the fact that ELOs will be marked and identified via the exchange’s proprietary datafeed, which could make them a target for high-frequency trading (HFT) firms. Nasdaq’s Cohen says he understands the concerns raised by some about information leakage—and says the exchange will consider changing this in future ELO versions designed specifically for the institutional community—but when it comes to retail investors, the main concern is around improving fill rates.

“When institutional traders are building positions, or working out of positions, we understand and appreciate their desire not to be attributed—because it could lead to information leakage, or may be part of a larger block that could inadvertently move a market,” Cohen says. “But an individual’s single retail order is actually the retail trader’s full expression of how much they want to buy. So to us, attribution seems well suited for retail at this time.”

Risky Business

For some, the increase in speed bump applications was a predictable, unwanted result of the SEC’s approval of IEX’s application. Jamil Nazarali, senior advisor and former head of execution services at Citadel Securities, says this is the situation his firm warned of during IEX’s application process.

“Exactly what we worried was going to happen is happening in that there is a proliferation of speed bumps, which means that the National Best Bid and Offer (NBBO) that you see is much less transparent, fair and accessible,” Nazarali says. “Every time you add a speed bump, the price that you see may not be the price that you can get. This makes it more difficult to manage risk, and creates complications for all market participants. We think this is a really bad development for the markets.”

Citadel has been critical of all speed bump proposals, already submitting multiple comment letters criticizing Nasdaq and CHX’s applications. For Nazarali, a market full of speed bumps will make it harder for firms to understand how to properly manage their risk because they can’t access quotes quickly as a result of the delays.

“Not only can I not get the price that I see on the screen, but I may have to send the order to the speed bump venue due to the Order Protection Rule. I would have to wait for that order to come back and be declined before I can go to the next venue to access that quote, and by the time I do that, the quote may be gone,” Nazarali says. “This creates problems for anyone trying to manage risk and trade quickly, particularly in a volatile and fast-moving market.”

Unreliable quotes will lead to uncertainty in the markets, which will lead to wider spreads, Nazarali adds. Firms conducting arbitrage trades will need to take on more risk, as they might have to hold on to one of the legs of their trades for a longer period of time, forcing them to widen their spreads to ensure their profit covers the additional risk.

“Over time, true value is going to deviate more and more from the stated price. I think the market will become less efficient for anyone trying to do a trade,” Nazarali says. “People will still get their trades done, but the price will be worse—it’s not going to be a huge difference, but depending on how big that component of the market grows, it’s going to have an effect.”

More Complexity

Northern Trust’s Vigsnes says added market complexities could include that the consolidated tape will no longer be in time–price priority sequence because of the potential delays from different exchanges. Firms will need to sort through how order types are implemented and what type of criteria they contain, he says, requiring firms to decide how to route orders based on that information.

With all these potential consequences, Vigsnes questions the purpose of these types of implementations, and who benefits from them. “What was the speed bump intended to do? It was intended to prevent the ability to see action in one market and react to it in other markets,” Vigsnes says. “OK, if you don’t want that behavior, then maybe you should do something from a regulatory standpoint that gives you the behavior you’re looking for, rather than throw out some arbitrary number like one millisecond, say it’s de minimis and see what evolves…. I think it’s a response to behaviors that market participants have said they want to be able to try and adjust, but I don’t think that it’s the right answer as a market solution for the whole market structure—it’s more like treating the symptom.”

Exchanges implementing different delay mechanisms with various lags could create further disparities, which is ironic considering the point of many of these additions is to lower the discrepancy between faster and slower participants, says Vishal Sood, global head of electronic trading technology and head of North America equities technology at Citi. But firms would simply need to adjust their smart order routers, which are already accustomed to the idiosyncrasies of different exchanges, to account for these additional differences, he adds.

Detractors of delay mechanisms have continually made the point that speed bumps will negatively impact the NBBO, and while Sood says more speed bumps would have an effect, it might not be as devastating as some suggest. Instead, because both the pre-calculated NBBO from the Securities Information Processor (SIP) and self-calculated NBBOs will both be subject to the same delays, he says it will create a level playing field. And while he doesn’t think more exchanges will implement speed bumps, he does see the market evolving via more order types similar to Nasdaq’s ELO, and looking to slow down of some of the faster participants.

Overall, though, Sood believes the industry should stop looking at speed bumps and new order types, and instead focus on making the markets simpler. The industry would be better off taking a step back and rethinking how firms trade, he says.

“The market needs to take a macro view and look at how to get out of this vicious cycle of continuing to trade in these smaller, little inefficient sizes,” he says. “I think if the exchanges keep adding new implementations, be it speed bumps or newer order types, they will keep making it more and more complicated. It’s going to defeat the purpose that they actually started with, which was to make it simpler for the participants.”

Like the trade sizes, the amount of market share potentially impacted is also small. IEX’s average market share has hovered around 2 percent since the start of 2017. CHX has maintained roughly 0.5 percent market share over the past year, while NYSE MKT holds approximately 0.25 percent during the same time period. ELO will be implemented directly on Nasdaq, which holds roughly a 14 percent market share, but as an order type and not a speed bump, it will be optional.

Unaffected

In fact, some believe they won’t be impacted by speed bumps. Broker-dealer systems will not be greatly altered if more delay mechanisms make their way onto exchanges because latency already exists across the different venues, says JP Chauvet, chief technology officer for equities at Deutsche Bank.

“Exchanges adding speed bumps does not change anything about how you would design an algo-trading or smart-order routing system. The industry… chooses where to trade based on execution performance. Latency is one of the parameters that we take into account in those routing rules. That has been the case for a long time,” Chauvet says. “There is no system change needed to factor an additional delay on one specific exchange, because at the end of the day it’s about execution performance and execution quality.”

Order types like Nasdaq’s ELO are a different story, Chauvet says, as those will have an impact on brokerages. Any firm trading with Nasdaq will need to support the order and then change its routing rules to either use the order type or not. But speed bumps will essentially be immaterial to broker-dealers.

“As a broker, we are really agnostic to this. We trade based on execution quality, which we measure both real time in our routing rules, as well as post-fact, where we really look at fill ratios and other metrics where we put all the exchanges in competition and then we basically route our volumes on those where the execution quality is best,” Chauvet says. “Speed bumps do not affect positively or negatively how we do that.”

Incumbent Weighs In

As for IEX, the newest national exchange remained relatively quiet on the topic for a while, perhaps avoiding the spotlight while waiting for the dust to settle on its recent approval. The exchange didn’t submit comment letters on CHX’s proposal, but sent the SEC a comment letter criticizing NYSE’s plans for the reasons previously listed in this story, and in March also filed a comment letter regarding Nasdaq’s ELO. IEX’s Ramsay also takes issue with both CHX and Nasdaq’s proposals, citing the former’s discriminatory design and describing the latter’s choice to attribute orders on its proprietary feed as problematic.

That’s not to say IEX is opposed to other speed bumps. Ramsay says that even if every market had its own unique speed bump that still wouldn’t make things more complicated than they currently are. “Each particular market operating has unique geographical characteristics. They all sell multi-tiered access. Most of them sell proprietary datafeeds. They all have these complicated pricing systems. So each market participant, in order to survive in that ecosystem, has to understand the unique features of that particular exchange relative to the others,” Ramsay says. “Whatever speed bump or delay mechanism anybody might impose—as long as it is clearly described—is not going to be that difficult to add into the mix of understanding how to deal with that particular market compared to the others.”

It’s not simply a matter of asking whether a speed bump is good or bad, Ramsay adds. The devil is really in the details of each offering. He does admit, though, that it could be a bad thing if a trend were to arise where individual markets were to adopt speed-bump mechanisms that selectively slowed down some participants compared to others.

“If markets are experimenting with ways to deemphasize speed as an advantage in a way that works for purposes for applying equally to all participants, and everybody did that, I think it could be a real advantage from the standpoint of the overall market structure,” Ramsay says. “Frankly, I think the ideal situation would be if you had four or five real exchanges—not just families of exchanges—that could offer somewhat different models but are competing vigorously with each other on the basis of service and execution quality and price. That would be a lot better system than the one we have today. And we’d like to be one of those, obviously.”