Larry Tabb Sees Big Problems With SEC Approval Of IEX Exchange
[Photo Caption: Securities and Exchange Commission - Scott S, Flickr]
By Mark Melin Sign Up For Our Free Newsletter and receive in-depth ebooks on famous investors
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Leading market structure consultant Larry Tabb, CEO and founder of the Tabb Group, is not nuanced in his thoughts about what will occur with market makers and high frequency trading participants after the Securities and Exchange Commission approved the IEX exchange application, and it isn’t pretty. In a report out Monday he lists eight predictions as to what is likely to occur in the future and notes that a legal challenge to a regulator is not one of the likely outcomes.
SEC approves IEX, sets minimum trading delay at one millisecond
In a report out one trading day after IEX won approval to become an exchange, Tabb, who had opposed the move, said that investors will be sorry.
After a long battle, IEX won approval at the Securities and Exchange Commission of its exchange and “speedbump” methodology which delayed all trades by 350 microseconds. The SEC also set a de minimis amount of time a trade could be intentionally delayed of 1 millisecond, settling the question of how fast is too fast.
“Today’s actions promote competition and innovation, which our equity markets depend on to continue to deliver robust, efficient service to both retail and institutional investors,” SEC Chair Mary Jo White said in a statement. “A critical role of the Commission’s regulatory framework is to facilitate the ability of market participants to craft appropriate market-based initiatives, consistent with our mission to protect investors, maintain market integrity, and promote capital formation.”
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The move by the government capped one of the most public regulatory fights in exchange history. The controversy was ignited when the book “Flash Boys” by Michael Lewis was published, starting a firestorm debate over the alleged market “rigging.”
Tabb says “investors will rue this day”
While the battle appears to be over in regards to the SEC decision, the fallout has yet to be seen – and warnings coming from Tabb, who is known for deep insight relative to the thinking behind the exchange structure industry, may raise cause for concern but also comfort.
“Investors will rue this day,” Tabb said in sharp and clear language. “Spreads will widen, retail investors will be hurt, larger buy-side firms will be disadvantaged, market structure complexity will increase, sophisticated trading firms will profit, and the quality of the US markets will deteriorate.”
In the report Tabb said the exchanges that will benefit are those with the lowest exchange volume. He looks at trading in Canada and tends to think the an order-type speedbump where only IOC (Immediate or Cancel) orders are delayed will prevail in the US. “This is a more likely model for the larger markets – the market in general would have a real-time ‘first in, first out’ matching methodology, but certain order types, whether IOC or others, are delayed.
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As a result, Tabb says complexity will increase, retail trade guarantees will become more problematic. The report cites eight primary problems with the IEX “speedbump” approval.
He says smaller retail investors will “categorically” lose and “sophisticated traders will most certainly benefit. “As markets become less deterministic, market makers and wholesalers will widen their quotes, hurting investors trading in smaller size,” he wrote. “As quotes widen, size typically increases, so larger investors will be able to trade in larger size with less market impact.”
Confusion around best execution points “will reign,” he predicted, with order volume on “dark exchanges” increasing “to the detriment of lit exchange orders.” Brokers will need to re-engineer routers and exchange routing will become less effective. Ultimately a speed bump means that “exchanges’ direct data will be a little less valuable” and brokerage costs will decline as their need to invest in high cost speed technology will lesson.
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In regards to potential lawsuits, an issue raised during the debate, Tabb thinks that there is a “minimal likelihood of litigation.”
“It is not wise to sue your regulator,” he said of a topic widely discussed among market participants. “So unless something drastically bad occurs, folks are not likely to sue over IEX’s approval.”
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