I haven’t read Flash Boys by Michael Lewis yet, but I will. After all, any guy who wrote Liar’s Poker, MoneyBall, The Blind Side, and The New New Thing deserves another $15.00 from me. Lewis consistently delivers insight and amusement. (For me, Malcolm Gladwell is a pretender; Lewis is the king.)
I am blissfully unencumbered by any real expertise on this issue, but after watching the 60 Minutes interview and this fabulous debate on CNBC Tuesday, I have come to a couple of conclusions on the matter of high frequency trading and exchanges.
1. Everyone agrees electronic trading has made markets/exchanges far more efficient. Bid/ask spreads are demonstrably lower than 10 years ago and any individual trader can pay $8.95 per trade for something that used to cost $100 or more in 1982. On an inflation-adjusted basis, this efficiency cannot be beat. No arguments on that issue!
2. There are exchanges, such as BATS, that seem to offer a business model which includes selling differential access to information based on the speed of connection to the exchange–or at least these exchanges allow participants access to trading information at different speeds. Many of the companies who prefer this model also seem to also own shares in the exchange. This may be legal and may be even be readily evident in the fine print of these exchanges.
No one said anything about this arrangement, until now, because:
- it is complicated
- in most markets we expect service providers to competing on speed!
- people are inherently lazy about reading fine print
- it involves tiny extra fees on huge volumes
- and there is a collective action dilemma (i.e., it is not in the interest of any one participant to figure out the implications of these rules)
As a result, it took a while for this speed-based business model to come fully to light and for people to start to evaluate its “fairness”. (Some observers believe this business model is inherently illegal, but I am not qualified to determine if the information high frequency traders had before others (for split milliseconds) constituted material, non-public information–or simply the free-market in action. Meaning that folks who invested in faster access were rewarded for their risk taking.)
3. The guys behind Flash Boys/IEX have set up their own exchange which has slightly different rules and does not allow speed of access to be a variable on which participants can take positions or gather information. Not surprisingly, this exchange is owned by, and frequented by, the folks for whom this is a better pricing mechanism–buyside players.
Why do I write about this? Because all exchanges and B2B marketplaces have rules of participation, different pricing mechanisms, and even possible subsidizations. It’s not surprising, for instance, that bank-owned payment networks funded their system with merchant fees. It’s also not surprising that many buyer-owned consortia charge suppliers and supplier-owned consortia choose to charge buyers.
Because so much of American wealth is tied up in equities and equity markets have recently been subject to bubbles, flash crashes, Ponzi schemes, and insider trading scandals (e.g., SAC), this issue of “fairness” for the little guy is highly sensitive and politically charged. In B2B, we can step away from some of this sensitivity, and focus on what is really important –which is that exchanges and platforms need to be clear on what they charge, how they charge, who owns them, and how they intend to use the data they gather. Various providers in procure to pay networks, for instance, still have completely different pricing models. As long as these networks are clear on their business models and they compete transparently, everyone wins.
BATS’s CEO basically said on CNBC that IEX simply had a different business model than their exchange. He really only objected to IEX calling the BATS approach “rigged”, thereby disparaging them, as opposed to just saying BATS has a different business model. The BATS CEO is also clearly insanely jealous, I’m sure, that his new competitor is getting record-breaking free publicity in the form of a book by one of America’s most successful authors to launch his business!
It looks to me as if the bottom line is that BATS was never fully transparent on how it worked and now they being badly out-marketed. Every exchange from Ebay to the London Metal Exchange has faced issues with respect to fairness, speed, ownership, etc. Communication and sensitivity are critical.
By the way, I’m optioning the rights to the Flash Boys movie. I’m not sure it will rake in as much as Lewis’s other hits such as The Blind Side or MoneyBall, but that CNBC debate is pretty entertaining stuff.