49: The Man Who Wants to Better Trading by Slowing It

SPEAKER_1 (0:00)

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Tracy Alloway (0:24)

Hello, and welcome to another edition of the Odd Lots Podcast. I'm Tracy Alloway, Executive Editor of Bloomberg Markets.

Brad Katsuyama (0:32)

And I'm Joe Weisenthal, Managing Editor at Bloomberg Markets.

Tracy Alloway (0:35)

Joe, this is a special, special episode of the podcast.

Brad Katsuyama (0:40)

It's special because we're not on it, right?

Tracy Alloway (0:42)

Yeah, it's extra special because we've edited ourselves out.

No, we are going to be playing an interview today that Bloomberg View columnist Matt Levine and a friend of this podcast, as you know, has done with Brad Katsuyama. He is the co-founder and CEO of an exchange that I think we've all heard of. It's called IEX. You might remember it from such movies as Michael Lewis's movies, such books as Michael Lewis's Flash Boys.

Brad Katsuyama (1:15)

Right. This was the exchange because there's been all this anxiety about high-frequency trading, right?

Tracy Alloway (1:20)

Exactly. So Flash Boys is about the evils of high-frequency trading and how they're messing up markets.

There were some examples in there that some people took issue with. But basically, high-frequency trading is the villain of Flash Boys. Certainly, a lot of politicians and regulators seem to be on board with that view. And then we had IEX that sprang forth from this guy called Brad Katsuyama, and IEX was basically the antithesis of high-frequency trading. They kind of install speed bumps to prevent people from doing that. And they're supposed to be a different way of trading, a better way of trading. And I mean, the book is worth reading. I don't know if you've read it.

But what's definitely worth listening to is this interview.

Brad Katsuyama (2:12)

Great. Well, this is an interview. It's associated with the November 6th edition of Bloomberg Markets magazine.

And I hope everyone enjoys it.

Matt Levine (2:33)

Thank There's sort of an origin story for IEX. You were a trader at RBC almost 10 years ago. You noticed that there was, that you'd try to buy 100,000 shares, you could only get 25,000 of them. You were wondering what was up, thought it was a software problem, eventually figured out that it was a sort of issue with the structure, with the deep structure of the US stock exchanges.

So you built a thing at RBC that would help your clients avoid that and get the full 100,000 shares. Then you were like, well, we can do this more broadly. And so you built a trading venue called IEX that did the same thing, that you coiled wire in a shoebox so that when people sent you an order for 100,000 shares and you had 25,000, you'd give them the 25,000. And before you told anyone else about those 25,000, you would run to the other exchanges, get the other 75,000 that were displayed, and give people the full size of their order.

And that was kind of like the origin story of IEX that's told in Flashboys, it's sort of a plot of Flashboys. I've seen you tell it on stage.

And now that you've become a stock exchange, it occurs to me that that story is not quite true anymore, right? Like the thing that is the sort of basis of the origin story is this router that skips the speed bumper that allows people to get all the shares before the high-frequency traders learn about it and can race ahead of them. And as part of the SEC process, you had to take that out. So I want to hear just kind of what your thought process on that was. Do you miss it? Was there ever a moment when you said we'd rather not be in exchange than do this?

Brad Katsuyama (4:00)

Part of the story was that we realized that when we were trying to buy or sell stock across the broader market that executions at the venues that we got to first would lead to fading of liquidity or trading ahead at other venues. And so we originally started IEX under the premise that we would be this router for clients that wanted to trade through any broker, could send a routable order to IEX, and we could get that order out to the market.

And that was the original premise that we started with.

And thank goodness, it evolves because we're routing, I think, 40 to 50 million shares a day. We're matching 10 million shares of that on our own market, which means that if that was our only premise, we would be doing a very small amount of volume on IEX and sending a lot of volume elsewhere. And I think the way that the concept evolved was to say, or ask the question, well, why can someone get a signal from one place and get to the next? And it really came down to co-location and this idea that people could pay to put their servers as close as possible to the exchanges, get fast information, and now with microwave connectivity, etc., can beam orders to other markets faster than people that are traveling through cable or people that don't have the same level of sophistication or have paid for the same level of access. And so when we thought about it, RBC as a broker could only solve a very narrow part of the problem. And the problem was broader because not only for orders that were routed, what about orders that are resting on the exchange? Or what about orders that are pegged on exchanges? How are those orders treated when there's this huge kind of disparity between who knows what, when? And that evolved into things such as discretionary peg and midpoint peg and basically the evolvement of the speed bumps. So I think if we had stayed as focused only on the router, I don't know if IEX would have made it because the router became secondary to our operation as a market.