Sunday, 12 July 2015

IEX - not walking the talk

The IEX Discretionary Peg (DPEG) order type should have no place in a transparent market place.

Let me meander through my reasoning...

I have no real problem with IEX other than I didn't really see the need for it which is a continuing view I hold. The people involved all seem pretty well intentioned, the ownership model is different without necessarily being better, the initial order types were simple and nice, and, in the beginning, IEX was transparent about what it did. It is no longer transparent.

The initial thought I had about IEX was that it was unlikely to be wildly successful as its "shoebox" delay line was simply turning the platform into a slow matching system with a virtual co-location space the size of New Jersey. That is not a recipe for success. Slow exchanges lose to faster exchanges as natural liquidity hubs and risk management centres; all other things being equal.

Jumping the shark


IEX introduced the DPEG order type a while ago and in December 2014 it was 11% of IEX's volume.

What is it?


You'll find the description of DPEG from IEX here which I reproduced in full:

Discretionary Peg Order

Upon entry, a Discretionary Peg Order is priced by the System to be equal to the Midpoint Price. Unexecuted shares are posted to the Order Book priced equal to the primary quote and automatically adjusted by the System in response to changes in the NBB or NBO. Discretionary Peg Orders can exercise price discretion to the Midpoint Price and respond to quote stability signals from the System. Discretionary Peg Orders are not eligible for routing and must have a TIF of FOK, IOC, DAY, or GTT.

Price Discretion: Discretionary Peg Orders will exercise the least amount of price discretion necessary, from their resting price to the less aggressive of the Midpoint Price or the Discretionary Peg Order’s limit price, to meet the limit price of orders entering the Order Book. When exercising discretion, Discretionary Peg Orders maintain time priority at their resting price and are prioritized behind any resting orders at the discretionary price. Discretionary Peg Orders are eligible to Recheck the Order Book to the Midpoint Price.

Quote Stability: During periods of quote instability, Discretionary Peg Orders are not eligible for Book Recheck and will not exercise price discretion. Quote stability is determined by the System based on an IEX proprietary assessment of relative quoting activity of Protected Quotations over a given period of time.

The bit that has always annoyed me as disconcerting is in the final paragraph above that I've highlighted, "based on an IEX proprietary assessment of relative quoting activity." You don't know what your DPEG order is doing. You can never argue that IEX has done the right thing or the wrong thing. If your DPEG order wanders in after a hard night out and claims it did its best for you, you can't really question it. All you can do is blindly trust and not verify. This is not how a transparent market place should operate.

Now, I believe DPEG probably provides a useful service to clients and is well intentioned. However, I also believe DPEG has no place in the life of an exchange. IEX is not an exchange. Does it have a place in an ATS which has a lower threshold of oversight? I'm not sure but I think it OK if the users want it in an ATS but I'm sitting on the fence as being generally unsupportive. I am strongly of the view that such unverifiable, opaque orders do not have any role in a properly regulated, fully licensed exchange. I hope IEX will remove it before becoming an exchange.

This is nowhere near the same category of dubiousness of a Pipeline screwing over their customers in their pool. Nor is it in the same dodgy territory as ITG misleading their customers about being agency only and yet making millions of dollars by proprietary trading against their clients' orders.

It goes to the role of order types in an exchange. I think this remains one of the bigger regulatory problems all around the world, but in particular with Reg NMS in the US. Too many order types and too much weirdness. This issue has not really been addressed since the crap work of fiction "Flash Boys" revealed it as one of the only valid criticisms to be highlighted by Lewis. I'm kinda happy about this as it gives me room to exploit order types, but it shouldn't be the case. The regulators should be depriving me of this opportunity.

I'd perhaps support an exchange making more complex order types, like IEX's DPEG, if such orders were made out of atomic orders and behaviours with no-special advantage. Effectively, offering layered services. Not within the ring of the matching engine, but in the same co-location space that clients also have access too so there is no disadvantage to client relying on the standard order types.

The SEC should force exchanges to stick to simple order types that are completely transparent to the point where a client could simulate the behaviour of an exchange from external market data. It's in the interest of any regulator to be able to review properly and "regulate" the orders of an exchange after-all. If you want a complex order type with weird behaviour, use a broker that you can trust. 

IEX, please go back to your principles and make a transparent market place.

Happy trading,

--Matt.

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