Focusing on Price Discovery

Eric Stockland
Jun 23, 2017 · 4 min read

Does IEX help or hurt price discovery?

Recently, several industry analysts and pundits have questioned IEX’s contributions to public price discovery because of our lack of displayed liquidity. The attacks are narrow and focus on a single dimension of price discovery, conveniently ignoring the others. They struggle to reconcile IEX with what exchanges are “supposed” to look like in their view — a view that omits the interests of investors.

How do exchanges promote price discovery?

One of the central functions of the U.S. equity market is robust public price discovery, the golden goose we all depend on. Without it, uncertainty builds, and the willingness to trade decreases. Price discovery takes several forms, but the two most notable are pre-trade displayed quotes and post-trade reporting.

What drives displayed quotes is pretty simple: rebates. Market makers want one of two things: to be the first in line to trade with incoming order flow, or as much insulation from adverse selection as possible. It’s no surprise that two exchanges, BYX and BX, have ended up with almost identical pricing on the inverted end of the spectrum, paying approximately 15 mils to spread crossers. On the other end of the make-take spectrum, there are 5 exchanges paying out 28 to 30 mils depending on pricing tier. In between is no man’s land — right where IEX sits, paying no rebates to either side of the trade.

In this landscape, our lack of displayed liquidity is the byproduct of one very conscious and principled choice: to not pay rebates. We eschew rebates because they distort prices, leak information, perpetuate excessive fragmentation and complexity, and ultimately create a conflict-laden environment that hurts institutional investors, who rarely receive rebate payments.

However, on post-trade price discovery IEX is a market leader. Trades on IEX, and in particular our midpoint trades, often reflect two naturals agreeing on price and in size. Contrast that to two intermediaries trading in small size with each other in the blur of a fast market and structural pick-offs. Which one better reflects fair value: 10,000 shares at the midpoint and a stable market post-trade, or several 100 share and odd lot prints in the midst of an NBBO change? It’s not even close.

For additional detail on the charts above, please see IEX’s recent paper, “A Comparison of Execution Quality across U.S. Stock Exchanges.”

So IEX does nothing for displayed orders, right?


Our model has several characteristics that make it a safer place to trade. We support only one method of order entry into IEX. We don’t sell different tiers of connectivity or even offer co-location. And IEX is the only U.S. exchange that aggregates quotes by price level exclusively, rather than providing more granular order-by-order detail that can enable order book profiling that is detrimental to investors.

We also only support a limited number of order types: those that facilitate a well-functioning marketplace. For instance, IEX doesn’t offer queue-jumping order types such as the Post Only Day ISO order that is typically responsible for “setting” the NBBO. We believe that aggressive interpretations of NMS and spraying the street with IOCs to satisfy crumbling quotes shouldn’t be a source of edge, even if it means IEX quotes join the inside a millisecond or so later.

Rather than subsidizing liquidity provision with rebates and esoteric order types, we incent it with execution quality. We remove price barriers to displayed trading — it’s free on IEX, as is our market data — boosting our standing on inter-market routing tables above the maker-taker exchanges.

No one ever asks “what do the incumbent exchanges do for displayed liquidity?” but the answer is: they incentivize it with rebates. Avoiding the conflicts and incentives created by rebates puts IEX at a disadvantage vis-à-vis our competitors, but we’re committed to a principled path of earning, rather than purchasing, the industry’s displayed orders. As always, when you read or hear attacks on IEX, consider the source and whose interests they represent — and whose they’re ignoring.

About IEX

IEX is the Investors Exchange: a fair, simple, and transparent stock exchange dedicated to investor and issuer protection. Built on the belief that every investor is entitled to the same right to trade on equal terms on every single trade, IEX is on a mission to level the playing field by eliminating unfair advantages from the markets.

On September 2, 2016, IEX launched as America’s newest stock exchange, and regularly matches over 140 million shares daily with a notional value of nearly $6 billion. IEX plans to begin listing publicly-traded companies in 2017.

© 2017 IEX Group, Inc. and its subsidiaries. Neither the information, nor any opinion expressed herein constitutes a solicitation or offer to buy or sell any securities or provide any investment advice or service. The information herein is believed to be reliable, but the Firm makes no representation as to the accuracy or completeness of, and undertakes no duty to update, information herein.

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