Institutional investors are backing a proposal from low-cost exchange provider IEX Group that would introduce a new discretionary limit order type that aims to help level the playing field on executing stock orders, according to comment letters submitted to the Securities and Exchange Commission.
IEX, operator of the Investors Exchange, filed the proposal with the SEC in December and said it believes that some market participants are currently able to predict imminent changes to national best bid and offer quotations because of their access to the fastest and most complete view of market data from all the major exchanges, according to an SEC notice of filing.
IEX says its proposal is designed to protect institutional investors and liquidity providers from potential adverse selection by "latency arbitrage" trading strategies, which some market participants use to immediately execute trades on other exchanges before the price updates.
IEX has asked the SEC to use a proprietary mathematical calculation that identifies brief moments in time when a stock quote is "crumbling" — a strong indication that the price is about to change — and then prevent stock orders in question from executing.
"Technological and regulatory changes in the U.S. equity markets have created some efficiencies, but they have also brought increasing complexity and unintended consequences, one of which is the importance of increasingly small speed advantages in determining execution outcomes," said officials from a group of asset owners, fiduciaries and advocates that collectively hold more than $3.3 trillion in assets, in a comment letter filed Monday.
The signers include officials from the C$201.4 billion ($153.8 billion) Ontario Teachers' Pension Plan, Toronto, the New York City comptroller's office, which oversees the $215.5 billion New York City Retirement System, and the National Conference on Public Employee Retirement Systems.
"These speed advantages have tilted the playing field in favor of firms specializing in 'latency arbitrage,' reducing the willingness of both long-term investors and market makers to display quotes, to the detriment of price discovery and market efficiency," the letter continued.
In a Feb. 11 comment letter, officials from the Council of Institutional Investors voiced similar sentiments. "We believe D-Limit is well-tailored to increase diversity and depth of displayed liquidity by protecting investors from getting 'picked off' by fast traders at key moments," its letter said.
Other stakeholders are not fans of the proposal. "Permitting an order type that allows systematic quote fading is not just novel, as even IEX acknowledges, but a perilous gimmick that creates a safe zone for illusory orders," trading firm IMC said in a Jan. 22 comment letter. "The U.S. equities market is the hallmark of transparency, reliability and liquidity for investors across the globe. Proposals that weaken competition and reduce the reliability of displayed liquidity should not be tolerated."
On Feb. 12, the SEC extended the comment period another 45 days, "so that it has sufficient time to consider this proposed rule change."
