FIA PTG submitted comments to the SEC today opposing a new proposed fee at IEX - the Crumbling Quote Remove Fee.
The proposal looks to increase the match fee for accessing IEX’s protected quote from zero to 30 mils – the maximum allowable fee under Reg NMS. However, this fee only applies to certain parties, and at certain times during the day when the IEX crumbling quote indicator (“CQI”) is active. FIA PTG believes this is a novel form of discriminatory pricing that creates an access barrier to the IEX protected quote applied to only certain parties and during select times.
IEX already has a non-discriminatory (at least among market participants) 350 microsecond delay mechanism that, when used in conjunction with its CQI, IEX claims prevents so-called latency arbitrage on their platform. The Commission approved this delay based on the fact that (a) it does not discriminate among market participants, and (b) that this particular intentional access delay was considered to be de minimis.
FIA PTG believes the IEX proposal is inconsistent with the Commission’s guidance in at least two aspects.
1. The Crumbling Quote Remove Fee (or Penalty Fee) is only charged during certain times and to certain parties. By design, the fee is intended to be discriminatory and thus creates discriminatory access to protected quotes frustrating the purposes of Reg NMS.
2. The Penalty Fee is based on IEX modeling price moves one full second after liquidity is taken. This cannot be construed as any form of so-called latency arbitrage as IEX had already defined that to be within 350 microseconds. Though IEX is not charging a retroactive fee based on where the market moves in one second, that is seemingly the purpose of the fee and it is only because the IEX CQI is not perfectly predictive that the fee is not effectively retroactive. As such, FIA PTG believes that IEX is essentially hampering (via a Penalty Fee) market participants from accessing its protected quote for one full second so that, presumably, those posting liquidity at the IEX protected quote can cancel and reprice those quotes at a new level. This time scale is almost 3000 times longer than the 350 microseconds the Commission considered to be de minimis when it approved IEX’s exchange application. As structured, this fee is not related to IEX matching costs, or any other inherent systems cost since at all other times accessing the protected quote is free. Rather, FIA PTG believes this charge is specifically designed to penalize and thus discourage certain market participants from trying to access an IEX protected quote.
The fact that IEX claims this charge will apply for only a couple seconds per day when the CQI is on is not germane to the determination of whether a practice is fair or discriminatory. More so, IEX states that 30% or more of displayed liquidity-taking orders are sent to IEX during those periods of time. This shows that the discriminatory fee will be effectively applied to a much, much larger percentage of overall IEX displayed liquidity-taking orders and belies the IEX justification that it is applied for less than 2 out of 23,400 seconds per trading day.
IEX provides no data or legal rationale for why orders that take liquidity prior to a subsequent one-second price move should be penalized with a discriminatory fee. It is our understanding that IEX’s protected quote is rarely at the NBBO. Thus, market participants will not normally access the IEX protected quote since it will be beyond the NBBO. However, there are certain times during the day where the IEX protected quote may be at the NBBO, and market participants may desire to access that liquidity. It should come as no surprise that these times would coincide with conditions under which prices may be re-adjusting. This, after all, is when most market participants are willing to cross the spread. But this is exactly the time that IEX proposes to impose its Penalty Fee.
FIA PTG believes that using the one-second price change as a justification for such a penalty frustrates the purpose of Reg NMS. The IEX protected quote is more accessible when it is not actually needed, but less accessible when it is needed. Further, the approval of a Penalty Fee that is based on a model of future profitability of a trade is unprecedented and would likely trigger a large number of extremely complex pricing structures with unknown consequences. IEX cannot characterize taking liquidity under these circumstances as latency arbitrage given the one-second model they are using. If the Commission approves this proposal we believe it will need to articulate a clear and precedent-setting rationale for an exchange charging discriminatory fees based solely on an exchange’s model of the future profitability of any given trade.
Though the IEX CQI methodology is published as part of the IEX rulebook, it would not be practical for market participants to replicate this exact logic in their own systems. Such participants would need to access the same data feeds used by IEX and timing discrepancies would likely yield different results. As such, market participants would not know whether or not they are subject to paying the IEX Penalty Fee when they send the order. This uncertainty in the match fee (zero versus 30 mils) can further frustrate access to a protected quote.
The CQI, together with its related functionality and fees, is yet another encroachment from a self-regulatory organization (“SRO”) into broker-dealer activities. We question why the exchange should be permitted to make broker-dealer-like decisions on behalf of its members without the associated responsibilities and liability. Historically, broker-dealers have been tasked with order handling, including price movement and best execution responsibilities. This proposed mechanism and fee provides the exchange this discretion while still enjoying the privileges of SRO status. This amounts to a slippery slope whereby exchanges compete directly with broker-dealers absent comparable liability, a distinct advantage that ultimately picks winners and losers through the cover of regulation.