Sunday, 13 August 2017

IEX fee regression

Public exchanges are meant to promote efficient price discovery and risk management. IEX thwarts such efficiencies.

IEX's new fee scheme further damages both price discovery and risk management. Let's meander through this.

The Fall of Icarus, 17th century, Musée Antoine Vivenel
Here is the filing IEX lodged for the fee change:  SR-IEX-2017-27,
"a proposed rule change to increase the fees assessed under specified circumstances for execution of orders that take liquidity during periods when the IEX System has determined that a “crumbling quote” exists" [p3]
That is, IEX is hiking the fees for taking prices, erroneously called taking liquidity, to the maximum fee allowed by the SEC, $0.0030 per share, when their crumbling quote indicator (CQI) goes off 350 microseconds into the future for a period of 2.35 milliseconds into the future, from your external point of view.

Previously IEX used rebates, a subsidised price of zero in this case, for displayed price taking orders that complied with particular volume constraints. Well kind of, if you hit a displayed price, yes free, but maybe for maybe not if hitting non-displayed prices.  Specifically, taking non-displayed prices costs $0.0009 unless,
"Taking Non-Displayed Liquidity with a Displayable Order and at least 90% of TMVD was identified by IEX as Providing Displayed Liquidity (i.e., the Member’s execution reports reflect that the sum of executions with Fee Code L and a Last Liquidity Indicator (FIX tag 851) of '1' (Added Liquidity), divided by the sum of executions with Fee Code L, is at least 90% for the calendar month​)"  [IEX web]
At least that is the old text. IEX has also filed a rule change for this to be specific to a particular MPID: SR-IEX-2017-25,
"Taking Non-Displayed Liquidity with a Displayable Order and at least 90% of TMVD, on a per MPID basis, was identified by IEX as Providing Displayed Liquidity (i.e., the Member’s execution reports reflect that the sum of executions with Fee Code L and a Last Liquidity Indicator (FIX tag 851) of '1' (Added Liquidity), divided by the sum of executions with Fee Code L, is at least 90% for the calendar month)" [p20]
The definition of "TMVD" was also changed to include an MPID reference,
""TMVD" means total monthly volume displayable calculated as the sum of executions from each of the Member's MPID’s (on a per MPID basis) displayable orders during the calendar month." [p19]
The MPID change is to be effective from September 1st, 2017.

Interestingly in this SR-IEX-2017-25, IEX admits it has been charging members incorrectly as it had been using an MPID based formula all along instead of the published and approved member method. Did IEX report the billing violation to the SEC as a separate event? Should the SEC step in and fine IEX for incorrect billing?
"IEX reviewed Member invoices since its launch as an exchange in August 2016 through June 30, 2017 to assess whether any Members were charged fees that differed from those described in the Fee Schedule. In other words, IEX recalculated the Non-Displayed Match Fee and the 90% threshold exception on a “per Member” basis (which is how the Fee Schedule currently reads) instead of on a “per MPID” basis (which is how IEX in practice had been calculating that fee). This assessment identified that nine Members were charged such differential fees in particular months, in some cases more than the fees described in the Fee Schedule and in some cases less than the fees described in the Fee Schedule. In total, seven Members were charged and paid $18,948.54 in excess fees and eight Members were not charged $44,175.28 in fees that should have been charged. Five Members were overcharged and undercharged in different months." [p14]
To add insult to injury, IEX is going after those people it has been incorrectly undercharging for the last twelve months. Bumper bills in September,
"IEX will charge..each impacted member for the net amount..underpaid and will be included in the August 2017 monthly invoices to be sent in September 2017" [p14]
I'm not sure how I'd define great customer service, but this would not be it.

Let's meander back to the main issue of charging the maximum fee possible for CQI conditions. It is not quite as simple as just charging the maximum fee under those conditions. IEX applies some threshold relief. The wording is a little poorly written for a formal document, but the idea is that the big fee applies if you do at least one million shares a month then it applies to the number of taken prices above more the number represented by 5% of the total executions, on an MPID basis.
"At the end of each calendar month, executions with Fee Code Q that exceed the CQRF Threshold are subject to the Crumbling Quote Remove Fee. Otherwise, to the extent a Member receives multiple Fee Codes on an execution, the lower fee shall apply."
" “CQRF Threshold” means the Crumbling Quote Remove Fee Threshold. The threshold is equal to 5% of the sum of a Member’s total monthly executions on IEX if at least 1,000,000 shares during the calendar month, measured on an MPID basis."
"Executions with Fee Code Q that exceed the CQRF Threshold are subject to the Crumbling Quote Remove Fee."
Apart from trying to make NYSE American's task harder, IEX's goal is to prevent adverse selection against price providers.

IEX reports,
"Across all approximately 8,000 symbols available for trading on IEX, the CQI is on only 1.24 seconds per symbol per day on average (0.005% of the time during regular market hours), but 30.4% of marketable orders are received during those time periods, which indicates that certain types of trading strategies are seeking to aggressively target liquidity providers during periods of quote instability. " [p26]
That is, IEX is looking to dramatically increase fees on 30.4% of marketable orders. If you read the bold statement in bold above you might find yourself nodding. IEX overstates this. Remember the CQI applies for 2,000,000 nanoseconds after it is triggered. When the CQI is a true positive, this means that if you want to trade on IEX when the price changes, then you pay a premium.

That is, IEX applies the highest price it legally can to discourage trading around the time the price changes. That is a harsh penalty that impacts the efficiency of both price discovery and risk management. I guess it is just the important times; those times prices change. Why would a trader want to trade at important times? Such an attitude goes against the explicit goals the SEC has memorialized many times with regard to the purpose of the National Market System. Then again, if you're a Franken-pool that prefers dark trading, why not permeate further your destructive to public market interest microstructure.

Another important feature of such a beast is that you can't always really decide in advance if your order will be subject to the CQI as IEX has the benefit of last-look, or looking into the future, within the exchange. You may only know after the event that a CQI applies, but not as you place the trade. Trading with an unknown fee may be less than optimal for some institutions. Best execution obligations are certainly harder. Perhaps it is best not to trade at IEX if you may be inadvertently violating best-ex.

Another amusing aside to the silliness of it all comes from the poor implementation of the CQI. When IEX changed to their new IEX Signal implementation of the CQI, they reported,
"On our example day of December 15, 2016, ... This new candidate formula would have produced about 2 million true positives and 2.1 million false positives." [The Evolution of the Crumbling Quote Signal, Allison Bishop, p28]
IEX has a pretty dumb one-size-fits-all CQI implementation that has more false positives than true positives - according to IEX. False positive domination means the CQI is normally fake news. That is, the majority of the time IEX charges you the SEC's legally maximum possible fee, their invalid rationale is invalid. You couldn't make this up if it wasn't true.

There are also two humorous outcomes relating to IEX's routing implementation. IEX's routed orders may be subject to an excessive CQI fee for a marketable order, particularly large institutional orders. Even funnier, it may perhaps be a best execution requirement that if there are shares available for an order elsewhere, the IEX router should not route to IEX as this will save clients' money due to avoiding the high IEX price taking fees. If IEX does not comply, then you'd hope the SEC will take action against IEX's violation of best-ex obligations. It would be funny to see IEX fined for routing orders to itself. That'd definitely be worth a chuckle.

IEX leaks information by design. It is more subject to latency arbitrage due to its SIP leakage and lack of fair co-lo. It not only prevents trading at price change time with its dark fading orders but now wants to discourage price discovery and risk management with high fees for when trading is needed most - at times of change. What happened to simple and few order types with simple and transparent pricing?

The IEX cult is becoming a lot more like the Flat Earth Society. I wonder if the mainstream media will ever call out IEX's misleading hypocrisy for the hubristic bullshit it truly is?

Happy trading,

--Matt.

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PS: IEX, instead of being greedy by taking the fee for yourself, you could generously provide some of it to the price provider. Would that be a compensatory rebate or a kickback?