October 1, 2013

The Buyside Takes Control

Long frustrated by the sellside and its order handling practices, IEX is opening up its own dark pool and forcing brokers to do business its way

By By John D'Antona Jr.

Long frustrated by the sellside and its order-handling practices, the buyside is set to open up its own alternative trading system-and asking brokers to do business there. 

The buyside is not going to take it. Anymore.

But is the already crowded and highly fragmented U.S. equity trading market, replete with 13 exchanges and 40 other trading venues, ready for another marketplace? The braintrust behind IEX, chief executive Brad Katsuyama, chief strategy officer Ronan Ryan, chief technology officer Robert Park and chief operating officer John Schwall all think so.

Robert Park, Brad Katsuyama, John Schwall and Ronan Ryan

Ryan and Katsuyama said IEX will address institutional traders' biggest concern regarding trading in broker-dealer operated dark pools: the inherent conflict of interest in order routing. The buyside has long argued that dark pool operators often route their orders to their own pools or desk first for execution, rather than send the orders to other pools. Brokers, the buyside says, are incentivized to complete orders in-house, as they can collect both sides of the commission. Also, there is concern the sellside is taking undue advantage of exchange rebates, choosing to post orders rather than trade against quotes immediately and pay a fee.

Also, institutional investors have publicly and privately lamented that extant venues, mostly public but in some cases private, are highly populated by high-frequency traders that only want to game their orders. These speedy traders are not concerned with providing liquidity or helping facilitate the block trades the buyside wants, rather they want to make money flipping small amounts of stocks. And they get paid mostly by rebates from the exchanges for providing liquidity.

IEX looks to end these issues, the execs said, by giving the buyside ownership of the venue and utilizing some features they want -no rebates for order flow, offering a limited number of order types and not colocating client servers with its own matching engine. And IEX will do this soon, Ronan Ryan, chief strategy officer at IEX Group told Traders Magazine.

IEX will start off as a dark pool in its initial two months, and will then file to operate as an ECN, displaying its best-priced quotations on the National Stock Exchange. IEX plans to become an exchange in the future. While operating as dark pool, IEX will be a fair-access, broker-neutral venue. All registered broker-dealers are welcome to become subscribers, Ryan said.

The concept of a buyside-only trading venue is not new-Liquidnet has run an institutional equities trading network for years. But the idea of the buyside actually owning a venue is. Liquidnet is privately owned. IEX did not disclose a full list of investors or member firms, but it did confirm that Capital Group Co., which runs American Funds (with $1.2 trillion in assets under management), and Brandes Investment Partners (with $25 billion in assets under management) are among its backers, as is Netscape founder Jim Clark.