Tuesday, 20 June 2017

IEX's new order's unintended consequences

IEX offered up for the SEC's consideration a new order type last week, "Proposed rule change to introduce a new market maker peg order."

The new Market Maker Peg Order, or MM-Peg, is not an unreasonable order type. I've long been on the record as opposing unnecessary order types and this fits that category. It is similar to order types on other exchanges. The innovation is limited. However, MM-Peg adds to the order proliferation pollution problem that IEX has long promised it would avoid. Here is an excerpt from Flash Boys concerning the puzzle masters,

(click to enlarge)

Back in 2014, IEX was promoting the idea of simple order types,
"Only four types of orders – IEX eschews certain types of orders that were created to accommodate the HFT crowd, such as the Post-Only order and “Hide Not Slide” order. Instead it offers only four basic types of orders – market, limit, Mid-Point Peg, and IEX Check (Fill or Kill). The Mid-Point Peg gives the investor a price between the current bid and offer for the stock."
Well, we've moved on from there with the Discretionary Peg and its complex conditions and changing formulae with its high false positive rates. The crumbling quote factor as been added to the Primary Peg. And now we behold the MM-Peg, a displayed peg that has priority over non-displayed. Not a big deal in itself as it is just a small incremental extension. A bit of an outhouse, really. IEX is simply replicating the same utility payoff for order type development that has got us into this NMS order type mess in first place. All may make sense in isolation but who wants to fly in such an NMS Rube Goldberg contraption?

IEX is no different from other exchanges with such order type development. The market order proliferation problem needs some kind of "start" agreement where these arms are controlled. The only real beneficiaries of the current proliferation are the sophisticated market participants that have the resources and skills to puzzle out all the order puzzles and apply them to their problems as solutions. HFTs might just fit into that category. IEX's biggest traders are HFTs. This may be the outcome they are looking for.

So, this little bit of hypocrisy on IEX's part cuts a little deep to their core values. This order proliferation has long been something the "puzzle masters" have protested loudly against. Not a big deal as a piece of incrementalism but, nevertheless, surprising as order type proliferation is a real problem to which IEX is succumbing. Why is it surprising? Well IEX has rallied against a number of things such as rebates and co-location, both of which may actually benefit markets and yet on order types - they continue to transgress on their values. Curious.

The big issue

The main issue I see with the MM-peg is that it may bake in a strategic advantage in latency to particular types of customers, "The Market Maker Peg Order would be limited to registered market makers" [page 6].

I read it that the repricing still has to go through some guise of 350-microsecond delay, perhaps even the original magic shoe box,
"Furthermore, pursuant to Rule 11.190(b)(13), each time a Market Maker Peg Order is automatically adjusted by the System, all inbound and outbound communications related to the modified order instruction will traverse an additional POP between the Market Maker Peg Order repricing logic, and the Order Book."
However, this isn't the problem directly. The problem is how the latency may compare to co-located access from NY5 where the POP is. That is, how does it compete against the exchange's own customers?

The exchange's network architecture should have reasonably good/low jitter due to it being 10G Ethernet. It is hard to do that really badly, so let's assume IEX haven't stuffed that up. The latency difference between customers in NY5 on the customer facing side of the POP and the internal MM-Peg repricing mechanism may then be implied to be significant for all or some set of customers. That is, significant in terms of expected jitter. That difference may be advantageous or disadvantageous due to those reified architectural differences. That is, the timing is largely baked in.

If MM-Peg was to have a benefit in terms of latency, that would be bad as you are forced to use it and eschew other order types, but only if you can. You may not be a registered market maker and be at a structural disadvantage. The other side of the coin is a baked on disadvantage implying you never want to use an MM-Peg. Then again on some day, it may magically improve due to some technical rejigging. What if it changes without you knowing and suddenly your trading is at a surprising disadvantage? I'm imagining Haim Bodek breathing fire. I agree with him. This is a poor situation.

Either faster or slower is problematic for IEX's customers. It is a no-win situation - caveat emptor.

And, just to add fuel to the fire, SIP customers may be notified of the requotes before the IEX customer waiting at the IEX pop.

Happy trading,



Note: much to do about nothing. This is all about an order type that lives "at least" 8% (IEX rule 11.151(a)(6)) away from the BBO if it is an S&P500 or Russell1000 name. Busy work that is an unprincipled precedent. You have to wonder why they'd bother with it.

PS: Kipp Rogers points out that it was only three order types back in the Flash Boy daze of 2014: 

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