Upstart trading platform pitching itself as an antidote to predatory HFT
http://online.wsj.com/article/SB10001424127887324170004578634040178310664.html
WASHINGTON—Some big Wall Street firms are throwing their weight behind an upstart trading platform pitching itself as an antidote to a mounting problem in the stock market: predatory high-frequency trading.

The platform, IEX Group Inc., will go head-to-head in October with established stock exchanges and "dark pools," private trading venues that don't publish buy and sell prices for stocks. Its aim is to nullify certain advantages enjoyed by high-speed traders, such as the ability to detect large orders by less fleet-footed traders and make trades ahead of them.

Its backers say IEX will provide a haven for firms that are looking to swap larger chunks of stocks, such as mutual funds and hedge funds. It plans to impose a uniform split-second delay on all trades executed on the exchange, offer a limited number of order types, and forgo the widespread practice among exchanges of paying firms that post orders on their venues.

IEX has garnered interest from firms such as Goldman Sachs Group Inc. GS -1.26% and J.P. Morgan Chase & Co., and has attracted financial backing from fund managers including Los Angeles-based Capital Group Cos., which manages American Funds and has $1.2 trillion in assets, and Brandes Investment Partners, a San Diego firm with $25 billion under management.

A Goldman representative said the firm sees IEX as "a true departure from the existing exchange models." More than 50 of Goldman's institutional clients have expressed interest in IEX, the bank said.

Still, IEX, with about 30 employees, could have a hard time steering enough trading to its platform to reduce the need for the high-frequency element, as it hopes. High-speed trading represents about half of all stock trading, and is seen by many experts as a necessary cog in today's computer-driven market, providing the steady flow of buy and sell orders that helps traditional, long-term investors trade.

IEX Chief Executive Brad Katsuyama, who spent about a decade designing sophisticated trading systems in New York for Royal Bank of Canada, says large money managers have become disillusioned with stock exchanges catering to high-speed clients. IEX's ambition, he says, is to "provide a common place" for such investors to trade in relative safety by curbing the ability of quick-draw firms to detect large orders and trade ahead of them.

That hasn't happened with other nonexchange trading venues, typically owned by a single broker-dealer. But no brokers will have a stake in IEX, which instead is largely owned by institutional investment firms and private investors. Mr. Katsuyama, 35 years old, hopes the distinction will encourage brokers to trade on IEX, since they won't be trading on a competitor's platform.

Regulators are turning up the heat on high-speed trading. The Securities and Exchange Commission is investigating whether stock exchanges have provided high-speed traders advantages over regular investors. The Financial Industry Regulatory Authority recently sent letters to high-frequency firms seeking more information about the computer codes they use to trade, with an eye on whether the firms have proper risk checks in place.

Unlike dark pools, IEX plans to publish traders' buy and sell orders. It will have four order types—commands that prioritize how an investor's orders are handled by an exchange—as opposed to the dozens of order types provided by exchanges that have drawn scrutiny from regulators.

IEX also will forgo the so-called rebates that many exchanges pay firms that help provide buy and sell orders. The payments, typically about 25 to 30 cents per 100 shares, primarily benefit high-frequency trading firms that provide orders.

At the same time, exchanges charge firms a fee for taking those orders. For firms that trade millions of shares a day, those rebates and fees add up to either a significant windfall or cost.

Many high-speed firms have designed strategies that allow them to pocket rebates, while brokers trading on behalf of fund clients typically pay the fees. IEX will charge a flat fee of nine cents for every 100 shares a firm buys or sells. Its hope is that firms trading solely to get a rebate will send their orders elsewhere, Mr. Katsuyama says, while brokers will pay a lower fee to trade than they do on exchanges.

IEX also plans to house clients' computers in a separate building from its own computer system, introducing a delay of 350 millionths of a second between the time a client sends an order from its server and when it reaches IEX's computers. Trade information exiting from IEX's system will have the same delay.

That is a departure from the practice at other stock exchanges, which place client computers in the same building as their own and have cut delays to less than 10 millionths of a second at times. The shorter delay gives high-speed firms the ability to react to trades at the exchange faster than other firms whose computers aren't housed in the same building, among other advantages.

While such protections have sparked interest among big investment firms, it remains to be seen whether enough will send orders to IEX. "We're hopeful that the platform will draw liquidity to it," said Matt Lyons, who runs global stock trading at Capital Group, an IEX investor. "The proof will be in the pudding."