IEX-Brad Katsuyama: A Stock Exchange to Fix the Problems of High-Frequency Trading

High-frequency trading (HFT) is a form of algorithmic trading that uses powerful computers and sophisticated programs to execute a large number of orders in fractions of a second. HFT relies on high-speed data feeds and low-latency networks to exploit minute price differences and market inefficiencies. HFT accounts for a significant share of trading volume and liquidity in various financial markets, such as equities, futures, options, and foreign exchange.

However, HFT also poses many problems and challenges for the market and other participants. HFT can create unfair advantages for some traders over others, distort prices and signals, increase volatility and systemic risks, and undermine market integrity and confidence. HFT can also enable abusive or manipulative trading practices, such as spoofing, layering, or quote stuffing, that harm other investors.

One of the pioneers who exposed and challenged the problems of HFT is Brad Katsuyama, a Canadian financial services executive. He is the CEO and co-founder of the Investors Exchange (IEX), a stock exchange that aims to fix the problems of HFT and create a fairer and more transparent market.

Brad Katsuyama’s journey to founding IEX began when he was working at the Royal Bank of Canada (RBC) as the head of global electronic sales and trading. He noticed that when he placed large orders that could be fulfilled only through many different stock exchanges, he was being taken advantage of by HFT firms. These firms, using their superior technology and speed, could detect his orders and trade ahead of him, driving up the prices and reducing his returns.

Katsuyama realized that this was happening because different stock exchanges had different latencies or delays in processing orders and transmitting data. This created an opportunity for HFT firms to exploit the information gaps or asymmetries between different exchanges. To counter this problem, Katsuyama led a team that developed THOR, an order-management system that split large orders into smaller ones and sent them to different exchanges at the same time, using intentional delays or speed bumps. This way, THOR neutralized the advantage of HFT firms and ensured fair execution for RBC’s clients.

However, Katsuyama was not satisfied with this solution. He wanted to change the system from within and create a new stock exchange that would put the interests of investors first. He left RBC in 2012 and co-founded IEX with a group of former colleagues and friends. IEX is an alternative trading system (ATS) or a dark pool that operates as a stock exchange under the regulation of the Securities and Exchange Commission (SEC). IEX’s main innovation is its use of a 350-microsecond speed bump for all incoming orders. This speed bump prevents HFT firms from taking advantage of their speed advantage and ensures that all orders are executed at the same price.

IEX’s mission is to level the playing field for all investors and promote fairness, transparency, and competition in the market. IEX does not sell its data or offer preferential access to any clients. IEX also does not charge any fees for removing liquidity or offer any rebates for adding liquidity. IEX also has strict rules and standards to prevent abusive or manipulative trading practices on its platform.

IEX’s story was featured in Flash Boys, a 2014 best-selling book by Michael Lewis that exposed the problems of HFT in the financial markets. The book sparked a public debate and controversy over the role and regulation of HFT in the market. It also brought attention and recognition to IEX as a potential solution and alternative to the existing stock exchanges.

Since its launch in 2013, IEX has grown steadily in terms of trading volume and market share. In 2016, IEX received approval from the SEC to operate as a national securities exchange, making it eligible to list public companies on its platform. In 2017, IEX listed its first company, Interactive Brokers Group (IBKR), followed by several others in subsequent years. In 2020, IEX had an average daily trading volume of about 223 million shares, representing about 2.5% of the US equity market.

IEX-Brad Katsuyama is an example of how innovation and entrepreneurship can challenge the status quo and create positive change in the market. By addressing the problems of HFT and creating a fairer and more transparent stock exchange, IEX-Brad Katsuyama has made a significant contribution to the market and society.