Securities Regulation Daily IEX exchange application continues to elicit support, criticism, as deadline arrives
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Monday, April 18, 2016

IEX exchange application continues to elicit support, criticism, as deadline arrives

By Kevin Kulling, J.D.

The SEC continued to receive extensive and spirited public comment about the application of Investors’ Exchange LLC (IEX) to become registered as a national securities exchange right up until the comment deadline. Since its original application in August 2015, IEX submitted several amendments, including one that made functional changes to its outbound router after extensive public comment was received over the original proposal. As the comment period comes to a close, the latest submissions to the SEC include support from several individuals while competitors remain opposed to the exchange application as currently drafted.

Citadel comments. According to a comment letter submitted by Citadel LLC, the amended application from IEX includes a proposed speed advantage for IEX pegged order types that is uniquely designed to enable certain inter-exchange latency arbitrage strategies. Specifically, Citadel says, IEX wants to intentionally and selectively delay the ability of market participants to place new orders on IEX or reprice orders on IEX, while allowing IEX pegged orders to reprice based on un-delayed high speed data feeds from other exchanges without being subject to IEX’s intentional delay.

Citadel concludes in its letter that the SEC should not approve the application unless it is amended to remove this “latency arbitrage mechanism.”

Aside from access delay related issues, Citadel’s letter says, one of the pegged order types proposed by IEX, called a “discretionary peg order,” is concerning because it would break new ground in the realm of predictive exchange order types. Allowing exchanges to offer such order types would set the market on a dangerous path of rapidly increasing exchange order type complexity.

“When considering negative consequences, it is important to keep in mind that now that IEX has withdrawn its proposed router advantage, the only purpose to be served by the IEX delay mechanism is enabling IEX pegged orders to reprice based on un-delayed quotations from other exchanges,” according to the Citadel letter.

Application. If its application for exchange is approved, IEX would shift from being an alternative trading system to a full-fledged exchange. IEX’s application has been the subject of both praise and criticism. According to the IEX application, users would gain access through a “point of presence” (POP) located in Secaucus, New Jersey. According to IEX, after entering through the POP, a user’s electronic message sent to the IEX trading system would traverse the IEX “coil,” which is a box of coiled optical fiber cable approximately 38 miles long. After exiting the coil, the user’s message would travel an additional physical distance to the IEX system, located in Weehawken, New Jersey. According to IEX, the coil, combined with the physical distance between the POP and the IEX system, would provide IEX users sending non-routable orders to IEX with 350 microseconds of one-way latency.

A number of commenters have asserted that the POP and coil access delay would preclude IEX’s best-priced quotation from being a protected quotation under Regulation NMS, an assertion that IEX and several commenters dispute.

In an order dated March 18, 2016, the SEC extended until June 18, 2016, the date by which the SEC shall determine whether to grant or deny the application for registration.

Proposed SEC interpretation. In a related matter, the SEC said that it preliminarily believed that IEX’s proposed POP/coil structure raised questions about the definition of an “automated quotation” under Regulation NMS. In light of market and technological developments since the adoption of Regulation NMS in 2005, the SEC is requesting comment on an updated interpretation to permit more flexibility for trading centers with respect to automated quotations to allow them to develop innovative business models that do not undermine the goals of Rule 611 of Regulation NMS.

The SEC proposal would interpret “immediate” when determining whether a trading center maintains an “automated quotation” for purposes of Rule 611 of Regulation NMS to include response time delays at trading centers that are de minimis, whether intentional or not.

Additional Support. In connection with IEX, the SEC has received many letters expressing support for the application as amended. A recent comment letter was submitted by Yale Law School students, who concluded that the revised proposal comports with Regulation NMS. The letter also argued that the application would comport with the statutory purposes and mission of the SEC and concludes by highlighting legal questions that would arise in the event that IEX’s application was denied. The letter says that denying IEX exchange status on account of its speed bump would raise a number of questions under the Administrative Procedure Act, including whether such an outcome could be viewed as an arbitrary and capricious determination.

Another letter from Yale Law School students also encouraged approval of the application, while noting the existence of unsettled issues, specifically whether IEX’s quotes qualify as automated quotations under Regulation NMS. The comment letter concludes, however, that IEX’s quotation is sufficiently immediate to merit Rule 611 trade-through protection, despite the 350-microsecond latency.

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