The US Securities and Exchange Commission has approved enhancements that IEX Exchange wants to make to its Retail Price Improvement Program to offer midpoint prices to retail investors and allow more interaction with institutional investors.
Ronan Ryan, co-founder and president at IEX Group, told Markets Media: “Institutions can interact with previously inaccessible retail liquidity and retail gets significant midpoint price improvement. This is the first time those two things have been married up on an exchange.”
In the US retail trades are not executed on exchanges but most are sold to market makers under “payment for order flow” agreements. The market makers internalize the flow and capture the majority of the spread, in return for offering retail investors a slight improvement on the exchange price.
There have been estimates that nearly half of total US equity trading volume is now being transacted off exchanges and the vast majority of that is retail trades.
IEX’s retail price improvement programme launched in October 2019 but the exchange filed with the SEC to make changes in order to provide the retail community with the ability to execute at the midpoint.
Ryan continued that, from an execution quality standpoint, the enhanced program is designed so that both the institutional and retail side will leave very happy, so IEX got zero pushback on the filing.
“The most ambitious change to our current retail programme is that, for the first time, we will flag when there’s liquidity available at the midpoint for retail orders,” he added.
The filing was amended so that IEX’s proposal to give price-time priority to orders from Retail Liquidity Providers (RLPs) was removed.
“When you blindly go into a venue hoping to bang into something, you will only find good liquidity approximately 2% of the time,” added Ryan. “On IEX, our retail liquidity indicator is for a round lot, generally 100 shares or more, at the midpoint, so it is meaningful and the probability of accessing that liquidity is high.”
He continued that IEX has already seen a lot of interest from RLPs and Retail Member Organizations (RMOs) for when the changes go live in about 30 days. As adoption of the order type grows and more data is produced, there will be more integration within algos.
“IEX is known for its very strong midpoint liquidity – and we have a few midpoint order types – so people have to digest this and navigate the different types of midpoint orders we have,” said Ryan.
He continued that a lot of people have been talking about getting retail order flow back on to exchanges for a long period of time, which was particularly elevated this year, and this is a unique solution designed to do just that.
“It’s a really cool innovation for people will be able to see displayed midpoint opportunity,” Ryan added. “Never before has there been so much transparency for the retail investor.”
Regulation
Ryan continued that IEX has talked to a lot of the retail brokers, wholesalers, full service and agency brokers that represent institutional clients about retail volumes.
“The general consensus is that there has been a floodlight shone on retail trading, particularly with the GameStop saga early this year,” he added,
Gary Gensler, chair of the SEC, said in a speech in London in June that he has asked staff to take a broader look at how the regulator might update rules for the current technologies and business models in the equity markets.
“I’ve asked SEC staff to consider the practice known as payment for order flow,” Gensler added. “We’ve seen a notable rise in payment for order flow in the U.S., something that you’ve banned in the United Kingdom. Canada and Australia also don’t allow broker-dealers to route retail orders to wholesalers in return for payments.”
The European Securities and Markets Authority has also raised concerns about these potential conflicts of interest between payment for order flow and best execution.
Gensler continued that 47% of trading interest is not displayed on the lit markets but executed by alternative trading systems, including dark pools, and by off-exchange wholesalers.
“Thus, significant trading interest on these platforms is not necessarily being reflected in the commonly cited National Best Bid and Offer quote,” he said. “I’ve asked staff to consider whether this equity market structure, as currently composed, best promotes efficiency and competition.”
Retail innovation
In addition to the IEX filing, other exchanges and brokers have also introduced innovations to give institutions more access to retail flow.
Cowen has allowed institutional investors to achieve better execution by adjusting their algorithms for increased volumes of off-exchange trading in the US equity market, which it labelled “inaccessible liquidity”.
The broker has developed an “Inaccessible Liquidity Adjustment” which allows clients to automatically adjust algos for the share of inaccessible liquidity in individual stocks for the first time as there is no way to identify “inaccessible” liquidity on the tape in real time.
Cowen calculates the percentage of inaccessible liquidity in each U.S. security on a weekly basis using data from Finra, the US regulator, which is only available on a historical basis. Clients can choose whether to apply ‘haircut’ participation rates across the board through an algo wheel, or for individual orders or in a customized strategy.
Jennifer Hadiaris, head of global market structure at Cowen, told Markets Media in March: “The key to our solution is that it is automated. The client does not need to know the amount of inaccessible volume in each stock and does not need to manually adjust their algos in order to achieve lower market impact.”
Nasdaq opening auction
Nasdaq changed its opening auction in May to give institutional investors the opportunity to interact with retail flow.
Chuck Mack, head of US equities at Nasdaq, told Market Media in June that the composition of Nasdaq’s opening auction is different from the close as a significant portion of the open is from individual retail investors.
The amendments include establishing an early order imbalance indicator (EOII) for the opening cross; extending the time period for accepting certain limit on open orders and changing cutoff times for on-open orders entered for the opening cross.
“Prior to the change data was disseminated at 9.28 ET and institutions could only interact passively,” Mack added. “Now data is disseminated at 9.25 and managers have much more flexibility to interact with retail liquidity.”
