Friday, 15 January 2016

One for the road: Failure-to-deliver, Goldmans & Reg SHO

I've long worried about the craziness of the US market with respect to fails-to-deliver, so I couldn't resist a new piece of SEC news where Goldman Sachs has been fined $15M.

As a trader when you trade via a broker you normally have an ETB and Restricted list to comply with.  For whatever reason, you can't trade stock on the Restricted list. An ETB is the broker's Easy-To-Borrow list of stocks that are OK to short as there is plenty of liquidity for loans if you're short at close of business. Often the ETB has quantities that represent the start of the day position but you can never really be sure at the close. It's not usually much of a concern to an HFT as your absolute position sizes shouldn't be too high as you churn the pennies out. You just stick to the stocks on the ETB list.

When stock or money is not delivered on the T+3 settlement there is a "Failure-To-Deliver".

So, Goldman Sachs have just been fined $15M by the SEC for violations related to this. Here is the SEC document. It makes for a fun read as it is easy to understand how the automated mundane of unquestioning workflows, and pressing the "F3" key, can arrive at such a point. The F3 key here turned into the FU2 key. It's the kind of boring detail that gets stuck in some business processing re-engineered workflow that gets ignored as people do interesting things until it rears its head and bites you in the ass to the tune of $15M. That's some bite.

I've long worried somewhat pointlessly about this.

The SEC publish fails-to-deliver twice a month. Let's look at the total share volume of fails for the last couple of full months:

October 2015 3,785,306,033
November 2015 3,722,780,135
update: Dec 2015 4,273,095,148

That's a lot of shares that don't settle on T+3.

Infact, it is more shares than a modest broker, who may be getting smaller, like ITG, may trade for an entire month. Here are the ITG numbers for November 2015:

ITG U.S. Trading Activity

# of

Total U.S.

Average U.S.
Daily Volume



Alert Daily

Trade Size

Avg. Trade
Size Ex-

November 2015


















Reg SHO is the weird piece of regulation that gives T+4, T+6, T+13 cascading forgiveness plus there is a DTC way of loaning and covering some of the madness. Unfortunately, some in the industry treat settlement as entirely optional. Sometimes it is because you'd prefer to cover that short in a day's time at a better price. Sometimes it is just because someone forgot something. Then there is just the poor practice of workflow rot that seeps through the cracks into a place like Goldman Sachs when everyone is trying to do things not so boring.

There are legitimate reasons why a failure-to-deliver should not be a huge deal but it should also not be settled for as a common settlement settling. Perhaps charging $10 per share or 10% would wipe out the practice smartly but that seems extreme. My prediction for 2016 is that this will largely be ignored and swept back under the carpet because it is so not so interesting except to ageing fintech geeks like me.

Happy trading,


Thursday, 14 January 2016

Happy new year and bye

It's 2016 and I've been sitting on the bench for a long time. Time to get back to work and feed the family. This somewhat unprofessional blog, and other media, will no doubt go as a consequence.

In the meanwhile, if there are any nice projects you may think would be mutually beneficial, reach out.

Happy trading,


CME to Shanghai - Uncle Kim?

Transit negotiations for the lowest latency path between CME and Shanghai would be interesting.

You'd better hire Dennis Rodman as a lobbyist.

Direct Path: Chicago to Shanghai via North Korea (Source)

Uncle Kim and Dennis hanging out: Source

Saturday, 2 January 2016

IEX - InvestorSexChange - the quest for validation & revenue

OK. Let's cut to the chase.

Q: Should IEX be allowed to become an official stock exchange?
Me: Yes

Q: Should IEX have protected quote status?
Me: No.

Huh? Those things are in conflict. How can it be so?

Firstly, I have nothing much new to say that hasn't been said already. If you're expecting some insight here, you should probably stop reading now and find a better way to start 2016. Here are some of the more educated opinions from people clearly smarter than me:
I'm not sure anyone cares for my thoughts on the matter. I've stayed quite quiet but a few people have asked politely for comment, so here are my meanderings.

Firstly, the IEX has been chugging along quite well. As you can see in the chart below, they are currently the third biggest ATS in tier one stocks by volume as at December 7, 2015 (coincidently my start to the 25th year of marriage, poor woman), according to the latest published statistics from Finra. They remain a small player in the overall market being reported to be around 1-2% of overall volume. Funnily enough IEX's biggest traders each day are usually HFTs as confessed by Citadel.
IEX - third largest ATS in tier one stocks (click to enlarge)
ATS data is provided via and is copyrighted by FINRA 2016


The positioning from those for and against IEX's exchange application has been pretty strong and vocal. Much of the debate, especially the Joanne Doe letters from many investors to the SEC as comment letters, has been rather silly and pointless, though often funny. Here is a link to the SEC letters.

The spoof comedy letter from a fictional town in Oregon with someone pretending to be a kid wanting IEX's application to be approved is perhaps the best example of facetious interest in the matter:
Subject: File No. 10-222
From: Danny Mulson
Affiliation: 8th Grade Student
December 15, 2015
Dear SEC,

I am a future stock investor, currently in the 8th grade at Aberdeen Middle School in Wetlawn Oregon. I whole heartily approve of the IEX plan to slow down trading.

Things move too fast in this world and we need to slow it down in every way we can. Take my school for instance. When we stand in line to pay for our lunch, we have two cashiers to pick from. There is Mr. Fields, who was recently fired from a data entry job. I heard he made some creepy comments to one of his female co-workers. But that isn't important. Mr. Fields can work that cash register like nobodies business. Even when twice as long, most kids will get in Mr. Fields line. Me, on the other hand. I prefer to get in Josephine's line. She used to work at the DMV before failing a drug test. I always get in her line. Sure, it takes me much longer, but she will always give me a compliment and ask me about my day.

In conclusion, IEX should be rewarded for slowing everything down and moving things backward. Cause backwards is awesome

Thank you for your time.
I'm pretty sure "Danny" is not referring to the SEC's Mr Fields and Josephine isn't a pun on Mary Jo White. Surely not. A follow up letter from the same fictional school in Wetland demonstrates why the SEC should have a little more rigour in the identification of bona fide credentials for letter acceptance.

Subject: File No. 10-222
From: Emma Hibernia
Affiliation: Aberdeen Middle School
December 23, 2015
Dear SEC:
I saw that letter Danny Mulson wrote to you. The Whole School Saw It. You need to know that Danny Mulson NEVER tells you everything he just tells you what HE wants you to know. 
OK Mr. Fields is fast. BUT Mr. Fields also takes 10 cents from everybody he checks out and when you complain about it he just laughs and says it's part of his job and everybody gets paid for their job so he should too. I thought he already got paid? But he said it wasn't enough. And suppose you want TWO milks well the first milk will cost you one price and then he charges MORE for the second one and you say they were all there to start with and the price tag was the same for ALL of them and he just says things change. WHAT CHANGED?? 
And Mr. Fields is creepy too just like Danny said but he didn't tell you everything at all. Mr. Fields got the cafeteria manager to make the GIRLS go down one ramp to the registers and the BOYS go down another ramp and the girls ramp is LOWER so instead of looking at us at eye level he gets to look down at us. Do you get what I mean?? So we complained to the cafeteria managers and they said it makes everything BETTER? And even though I begged her NOT TO my mother complained to the school board and they said they would put it on the agenda for like some meeting a gillion years from now after they talked about parking and everybody is already DEAD. 
Very truly yours,
Then you see part of the problem with a well meaning letter from a Professor of Physics, if a true letter that is,
Subject: File No. 10-222
From: John B Rundle
Affiliation: Professor of Physics, University of California

December 31, 2015

I strongly urge that IEX be granted the status of a national exchange. Please do not let the opposition of an entrenched few competitors roadblock their application. All investors want and need increased transparency in trading of securities.
Finance and market structure seems a field far removed from Professor Rundle's field of earthquakes. Michael Lewis wrote a largely fictional work in Flash Boys where the old mates of Lewis from one of his prior fawning books, "The New New Thing" (a fun read), invested in Spread Networks and IEX. The stupidity espoused as fact in that book, and 60 minutes subsequent "insights", has stirred the pot with many readers believing the crap about Reg NMS being broken because Michael Lewis told them so. Perhaps Professor Rundle and many other letter writers fall into this camp of mistaken fan girls and boys. If the Lewis story was correct their outrage would be well placed, but the Lewis story is an improperly researched fraud perhaps biased by his prior friendships from parties related to "The New New Thing." As an ageing HFT guy I certainly have my own prejudices.

Professor Rundle's letter is amusing as much of the benefit in market structure from IEX, yes there is benefit, comes from the DPEG order type. IEX's DPEG is complex, hidden or dark, and not necessarily an order a retail customer would easily understand nor lodge via their broker. In December 2014 IEX claimed its use was increasing and was then up to 11% of volume. This kind of order is beneficial to many users, not so great for some others, but parasitic, like most dark orders, with respect to market structure. I don't think Professor Rundle understands this opaqueness based on his short letter referring to transparency.

I wrote disparagingly about the IEX DPEG a while ago saying that IEX should not be allowed to become an exchange with such a proprietary order type that had such unknown workings. It was a good example of IEX espousing virtues of simplicity, transparency, and openness and not walking its own talk. I'm glad to say IEX largely fixed those issues of "magic" workings with a more detailed explanation of the DPEG in their exchange application, though they failed to properly disclose timing related issues. Ironically, this order type is exactly the kind of complex order Michael Lewis and Brad Katsuyama were both rallying against in Flash Boys. One woman's terrorist is another woman's freedom fighter.

IEX benefits

The DPEG is a pretty good order for HFT types. In a simplistic sense, it may allow you to sit on the bid or offer and be protected from some adverse selection with DPEG's last-look like facility. This is due to the fact that IEX uses current market data without any delay for crumbling quote protection versus stale magic shoe boxed data otherwise. DPEG is parasitic to market structure as it is only valid in a market environment that provides an appropriately efficient context.

Apart from that benefit, I can't really see any benefit from IEX apart from the fact that they have good ethical people running the exchange, like many other exchanges, with a particular customer segment, institutional investors and HFTs, they suit best. HFTs and IEX? Yep, remember Virtu was one of their larger early customers and in Citadel's comment letter they noted that on some trading days Citadel themselves were the biggest trader on IEX. 

Fundamentally I believe IEX has a very poor business model as it sails against the forces of efficient price discovery and risk transfer. Historically inefficiency in an enterprise makes for a shortened life span.  Once you also figure in their more expensive than normal transaction fees, long term survival seems unlikely. They have great marketing and mind share, as you can see from the letters submitted to the SEC, thanks largely to the effect of Mr Lewis and Flash Boys. At the end of the day, failure or adjustment of course seems the only likely outcome for IEX but that may be years away. They have good momentum.

The mistake that became IEX

In Flash Boys, Lewis describes Brad Katsuyama as a broker that developed a new insight into the market that led to the tool Thor at RBC. Thor could hit every bid or offer in the market by timing the order releases so the child orders would hit every exchange concurrently. So much for phantom liquidity. Turns out it was real. Basically Brad was being paid $2 million a year to execute badly for his clients as many others in the market already knew this somewhat obvious fact. So Brad mistakenly thought he was on to something and decided if he could slow down every order at a new exchange then he could prevent his customers being picked off. So, off he went and created IEX on this dumb premise. It was dumb premise as slowing down the orders just makes you an inefficient and slow exchange. You're still susceptible to faster traders picking off orders as it remains a race to the order queues as I pointed out previously and Citadel also noted in their SEC comment letter(s).

The eventual development of the DPEG order added a benefit due to the differential nature of the use of use of market data. Using current market data when others see delayed market data is the same as seeing into the future. So DPEG is useful to some, but it has to be understood to be parasitic and thus unworthy of market defining use in the large. That is, there is nothing wrong with parasitic if it is useful and doesn't destroy the host where the host is the NMS in this case.

A truly fair and efficient exchange

The best exchange for retail and institutional investors would look somewhat different to IEX but largely solve the same problems that Brad set out to solve. It would have the following features:
  • the lowest match and report latency (efficient)
  • length matched cabling in a co-location facility (fair)
  • no feed back on order lines, e.g. one way UDP in (no canaries)
  • common market data for all that includes coded order feedback
  • low latency microwave market data piped in, including CME (assist fairness for all)
  • simple order types, add, delete, modify for limit/ioc and that's about it (think Nasdaq UFO/Ouch)
  • carefully calibrated, low, and simple transaction pricing with no volume level breaks 
Plus a few other features. This would make for a seemingly simple exchange that would have the winds of efficiency in price discovery and risk transfer at its back providing a natural liquidity sink and business momentum. Ironically HFTs would not like such an environment as it would be very difficult to get any kind of competitive edge on their brethren. However, many HFTs also would like a simple exchange where there was no obvious disadvantage to blind side them. That is a constant HFT theme. HFT's like to find an edge on their competition, but prefer low latency simple environments without disadvantage where it is ironically hard to find any edge.

If you look at the above list and count the number of those features IEX has, you quickly get to zero. IEX could do better. There is still space for simple innovation in the exchange space at least.

OK, OK, get to the point, should IEX be an exchange?

Yes, I think IEX should be allowed to be an exchange based on my principle that it offers a bit of innovation with the last-look DPEG, it is acting honourably, and it is no worse than other platforms.

IEX's "look at our pretty colour" marketing does not appeal to my inner engineer that wishes for proper purpose. However, just because the IEX business model is a bit daft and its presence is suggestive of petty pretty pointlessness doesn't mean it shouldn't be allowed to be an exchange. IEX should be allowed to be stupid and fail. Stupidity is not a crime.

I certainly don't think IEX should be allowed to be an exchange with the non-delayed order routing by its broker dealer. We don't need an escalating war of delayed routing between exchanges screwing up the NMS. However, this could be dealt with by the SEC in a conditional approval. Similarly I think IEX's original application was flawed in terms of disclosure around workflows with respect to timings and delays but this was largely corrected, when forced by complaint, in further submissions. The poor form of the original application in this regard could result in the SEC denying and asking for a fuller reapplication, perhaps with a shortened process if that is allowed, but I don't think that is necessary given the widespread debate and current information. Minor corrective submissions or comment should be enough.

The purposeful delays in IEX's system should also make it that so they don't get protected quote status for their prices within the NMS. Quotes should be tradeable. A solution, such as Thor, should find real executable volume to the best of an exchange's ability and not a significantly and purposefully delayed rear view mirror of the past. If you want to read about protected quotes in Reg NMS Sec 242 Rule 611 and friends, please do. Simply put, exchanges' quotes are protected in that every broker must seek the best price amongst exchanges for their clients. You have to go to the exchange with the best price even if you think it is a tinpot exchange and not necessarily in the best interest of your client. The delays inherent in IEX should not force that upon the required parties.

That is kind of interesting as I don't think it even makes sense to be an exchange if your quotes are not protected quotes. It just makes you an ATS. Also I don't think the SEC even has the latitude to make such a ruling within the context of Reg NMS. This would mean that the SEC can't give IEX exchange status. However I think this reflects poorly on Reg NMS rather than IEX. I think IEX should be allowed to be an exchange with the basic conditions I've cited. Likewise participation in the consolidated tape revenue should be seen as problematic for IEX due to their delayed quotes.

Other arguments

Some people think the 350 microsecond delay IEX put on their system through a common POP in NJ should be enough to kick them from consideration. Reg NMS doesn't support purposeful delays. IEX replied that exchanges already delay in their co-location centres by having standard cable lengths and thus delaying some participants for fairness. Both sides seem a bit wrong there. The 350 microsecond delay is not comparable to the around 300 nanosecond delay implied by extra cable length. There is a 1000 times difference. Hardly comparable.

Even so, 350 microseconds of delay should not be a big deal in the current Reg NMS context. It is perhaps stupid but I don't think it should be considered improper. The fairness philosophy is a good one, not because others do it at 300 nanoseconds, but because it is a good thing.

At one level the 350 microsecond delay, thanks to the magic shoe box, is the equivalent of making the IEX system a co-location facility the size of NJ. That is, just a slow exchange for all. However the differential use of faster data within IEX, such as with DPEG and their routing, makes it quite a bit different in some regards.

Where I think there should be traction in the voice of disapproval is that IEX is essentially a slow exchange. IEX provided numbers in their application and you can go and look at the cute graphs. I don't like the idea that slow exchanges should be approved and gum up the system but there is no regulation against it. Reg NMS is certainly not really designed for protected quotes coming from Chicago nor the West Coast, let along for slow exchanges near NJ/NY like IEX. In Reg NMS there is verbage of the form that as long as something happens in the last second things are OK. A whole second. How quaint. There are 1,000,000,000,000 picoseonds in a second. Reg NMS needs some revision.

There has been much talk around having a minimal latency threshold, such that platforms shouldn't be allowed that slow the NMS down, but that regulation doesn't exist. I personally think something harsher should exist so that if you are below the current median performance of all exchanges you shouldn't get a guernsey on the basis that you are not improving the system, you're making it worse. That is not a thing. I also think there are too many exchanges and they should be more rigorously controlled but that is also not a thing. These are problems with IEX's application but they are not IEX problems. They are problems with Reg NMS and it would not be fair to exclude IEX on this basis.

Reg NMS has resulted in a pretty good system. As good as the NMS is, it has issues that could be improved upon. The bottom line is that there are worse existing problems to be found than those in IEX's application.


In summary, IEX should be allowed to be an exchange subject to the B/D conditions and without being allowed protected quote status. However I don't think this is possible within the current regulatory framework. Such an approval is likely to be unlawful. I guess we'll have to wait and see. The people at IEX are good people and deserve the status they are seeking so let's hope they can make some headway in reforming the system eventually.

After all, it is wrong to deny people the good grace of capitalistic failure.

Happy trading,