The Perverse Incentives of Stock Exchanges and Their Data Monopoly (w/ Ronan Ryan)


TYLER NEVILLE: Ronan Ryan, here we are. President of IEX, but also well known for
a character in Flash Boys, in Michael Lewis’ book. Thanks for having us in your office. RONAN RYAN: Character of myself. TYLER NEVILLE: Yes. A character. Yeah. Huge character. So, wanted to dig into your background. Why don’t you tell us how you got to IEX and
how you met Brad and take us back. RONAN RYAN: Yeah, it’s a funny story. But I actually met Brad and worked for Brad
at RBC before we formed IEX. I had worked in the telecom sector for years,
had originally wanted to work on Wall Street. It’s in the book, but I could not get a job
on Wall Street. So, I took a job and learned technology on
the telecom side. And then it was around 2004, trading and technology
started banging into each other. And by that, people started to care how fast
they traded. And I happen to be in the right place at the
right time, you make your luck, but you got to be lucky, I was at a company called Radiance. And I got a call one day from a black-box
trader and not knowing what the hell a black-box trader was, and had said, look, you know infrastructure,
if I move my strategy from Kansas to New Jersey, can you collocate me, meaning put me in a
data center near the exchanges? And I’m like, of course, we can do that. And it was funny story and that he was complaining
over the phone how it takes him 43 milliseconds to send a trade from Kansas and to receive
acknowledgement of the trade. And I had no idea what a millisecond was. But I told the guy I’m like, yeah, that sounds
terrible. And when we moved them, we lowered it to 3.9
milliseconds, which sounds Fisher Price slow now, like 15 years later, but at the time,
this guy was thrilled, he was so happy with the move. And anyway, he was introduced to me by a prime
broker at a Bulge Bracket. And I went back to the prime broker at the
Bulge Bracket and said, do you have any more of these black-box traders and I guess black-box
traders became high frequency traders. And I started building out a lot of environments
for all these guys to move to New Jersey, connect to the exchanges, then the exchanges
themselves got into the business of selling space and selling technology and even selling
circuits to connect their own clients to their competitors, which is bananas. But that’s where it morphed to. And I wanted to move to the business side
and was meeting with a lot of brokers. And then one day, a broker called me and said,
would you talk to the Royal Bank of Canada and went in there and met with about 17 people,
which is how brokers interview apparently, and just started working a few weeks later,
and we were working on the trading floor. I was working with Brad, when we came up with
a Tor smart auto-router, was like famous for arriving at all venues near simultaneous to
get the best fill rate that took off. RBC did remarkably well. But then a lot of clients said to us, we can
only use your technology when we trade with RBC, if you think of something bigger, we’ll
support you. And that really was it. So, we looked at it and said, well, the center
of the ecosystem are the stock exchanges. So, why don’t we launch a stock exchange? He says not that sounds none of us have ever
even worked at a stock exchange. And we set out to build one and there was
Brad, myself, John Schwall, our COO, and Rob Park, our CTO were the four first people who
came up with this idea. TYLER NEVILLE: One thing I want to talk about
in this interview is market structure, which is an overarching, if you want to go David
Foster Wallace, it’s the water that’s around us in investing that no one really pays attention
to. And I think it’s such an important piece of
the investment component that most portfolio managers don’t understand market structure
and liquidity, and it’s a huge gap in knowledge. So, can you take us back in time to like the
’90s and start maybe there when regulation started coming in? And the market got fragmented and gave us
a history there? RONAN RYAN: Yeah, happy to. And before I do that, I will say this, it
was remarkable to me when the book first came out on Flash Boys in 2014, the buy side traders
had become well enough versed in market structure. But because the book shine a light on equity
market structure, a lot of the portfolio managers asked us to come in and present to them. And it was only then that I think they realized
that the work of the trader itself, the buy side trader was far more detective work than
they had imagined. I think people had thought with the electronic
application of everything and you just plunk it in algo, set it and forget it and everything’s
fine. And I think it was then that those PMs that
showed an interest in that really respected how many venues exists and how their traders
source liquidity. So, I guess it would go back to like the ’90s. The first thing was like reg ATS. ATS was alternative trading system. It just allowed more competition. So, you have, today, you have stock exchanges,
and you have ATSes. Another word for ATSes that most people know
them as are called dark pools. But an ATS is basically a baby exchange. It’s a less regulated exchange. And really, up until the ’90s, you had the
NASDAQ and the New York Stock Exchange, and you had the regional stock exchanges, but
they had very little volume and then late ’90s, you started with the advent of Archipelago
and INET and those were 100% electronic exchanges, no humans involved- as well as NASDAQ in fairness,
which was already a few decades old, but the electronification and the fragmentation of
the market let itself the competition and then in the early 2000s, there was decimalization
where you could trade in penny white increments. And then also, you did see a lot of his exchanges
started to buy- the incumbent exchanges started to buy the smaller guys. Why? Because they had better technology. So, NASDAQ now runs on old Island INET technology,
New York Stock Exchange bought Archipelago, didn’t really adapt to the new technology. I think they’d been rolling out their new
pillar platform for the last few years. But in essence, they bought those platforms
because they didn’t want to compete with them anymore. And they wanted to avail of their technology. But with all of that, I think there was a
great book, called Dark Pools that was written by Scott Patterson, and it’s all about market
structure and the chronology- I’m not sure if you’ve read it. And if you haven’t read it, you should read
it. Because it do a much better job of answering
this question. But it has the entire chronology of the creation
of INET and ARCA and just even the messaging like everything now is all trading is done
in like fixed protocol, just the invention of fixed protocol, the dissemination of market
data. But it lends itself to collocation, meaning
collocation came about in the early 2000s, where the biggest proponent of latency of
delay, a fancy way they say, propagation delay. It just means the further away from the signal
you are, the longer it takes you to get the signal. You’re in California versus New Jersey, or
New York versus New Jersey, which is funny, because you have tons of exchanges like Chicago,
Boston, New York, Philadelphia, IEX, all 13 exchanges are in New Jersey, and all of them
are in four buildings in New Jersey. And that’s more often because people want
to be in the same building as the exchange. So, from back when I was telling you before,
3.9 milliseconds mattered back in 2004-2005. Now, if you collocate, meaning, you put your
strategy in the same building as the exchange, so you’re as close as possible to the exchange,
that latency is measured in nanoseconds, which are billionth of a second, which is again,
comedic because when people first moved to the building, they wanted a cable to connect
to the matching engine of the exchange. Now, it’s gotten to the point where people
are complaining that client A’s cable is shorter than me, so they can get to the matching engine
quicker than me which again, it’s 11.9 inches, I think, technically, but roughly, a foot
of cable equates to one nanosecond. So, what New York Stock Exchange got a lot
of credit for is they measured the furthest cabinet away from their matching engine, and
gave everybody the same length of cable, which people found interesting but the one a lot
of people haven’t heard of, I thought, was really interesting is then the people closest
to the matching engine started to ask the New York Stock Exchange to move them further
away because a straighter cable had less light refraction and was must have been trillions
of a second faster. TYLER NEVILLE: So, it’s gotten that ridiculous. RONAN RYAN: Yeah. So, it’s gotten that ridiculous, and it continues
to get more and more so. So, every little increment of speed, like
if you run a strategy that’s sole determinant of success is based on speed, if you fire
in response to a signal at the exact same time as someone else, and you get into the
matching engine, a billionth of a second before them, well, then they’re second, you’re first,
or vice versa, you come in second and they’re first, that equals success. So, many strategies, not all strategies, but
many are predicated on being the fastest of the fastest. So, there’s an entire industry, an industry
in which I guess I grew up in was then making every facet of the trading cycle faster and
faster and faster. And the ironic thing is, I’ve never traded
a day in my life. I’ve never traded a day in my life. But I spend a lot of time talking with traders,
telling them how they should navigate a market. I’m not suggesting we tell them how to trade. TYLER NEVILLE: But the funniest part is you’re
probably the most qualified trader on the Street by knowing all the technology. RONAN RYAN: Just use a watered down Irish
accent and a few f bombs. Actually, from him. TYLER NEVILLE: We checked and drop them. RONAN RYAN: I’m allowed on camera. TYLER NEVILLE: Yeah. But so, the decimalization happens, spreads
completely tightening. But what’s fascinating is, liquidity has gone
down since 2007, which is really bizarre to me. Do you have any perspective on why that is? RONAN RYAN: Yeah. The average daily volume is down around what
like 7.1 billion shares a day now. And I think it spiked close to 14 billion
in 2009. Numbers might be slightly off. But in and around that realm. I think what you’ll find is, and we’ve often
said this, there’s a lot of unnecessary liquidity, even in the current market, meaning there’s
buyers and sellers in the market at the same time. The problem with the market is there’s 13
stock exchanges, 30 plus dark pools, and the buyer and seller are in at the same time,
marketable against one another, but they’re just not in the same venue. And then what happens is someone will buy
from the seller in one venue, maybe 100 shares at a time, and go and try and find a buyer
in another venue. But what that does is it’s like the triple
threat. You’ve 10,000 shares enter one venue, 10,000
enter another. Optimally, you’d like to see the 10,000 shares
trade with one another. But if someone buys from this seller, sells
to this buyer, and they just go 100 shares at a time and they eventually satisfy that
trade, while the tape sees 20,000 shares. So, when a portfolio manager is giving an
order to their traders saying, hey, maintain 10% of volumes, so 2000 shares because there’s
20,000 shares. Well, really, the real volume in the market
in that instance, was 10,000. There was a natural 10,000 buyer and 10,000
seller. So, there’s a ton of just bullshit liquidity
out there. And it doesn’t matter what broker you use,
what algorithm they use, there’s no algorithm that could possibly have gotten you that 20,000
because there just wasn’t 20,000 of interest to begin with. But more importantly, it causes people to
maintain a percent of volume just as an example, instead of 1000 shares, 10% of 10,000. Now, you’re buying 2000 shares, 2000 shares
might force you to cross the spread out in New Jersey, send an order out, spread out
there, crossing the spread causes the quote to change. When the quote change, the person who knows
the quotes change first has an advantage over everybody else. It was cyclical. So long that that answer to your question,
in that instance, a huge percentage of that liquidity is just unnecessary doubled liquidity. TYLER NEVILLE: Yeah. So, my perspective- and I was at a giant $800
billion asset manager before, and we had these different mandates for stocks where you had
to maintain a certain percentage say it was 20% of the time. So, being 20% of a daily volume, just a couple
of years ago, you were really mimicking maybe 40% or higher of that traded volume like you’re
saying. And that might even lead to underperformance
on your overall funds, when you’re trying to move an aircraft carrier in a tiny little
river, it’s almost impossible to do. RONAN RYAN: It’s impossible to have no impact. Just two weeks ago, I was with a large buy
side institution that has- it’s consolidating a bunch of others as more people acquire one
another, and they’re getting bigger and bigger. And their head trader was telling me it’s
a pain in the ass, as people will say, well, if you don’t want to have impact, just lower
down your percent of volume to like 3%. But if you’re trying to get a position on
and you’re doing 3%, 3%, depending on the size of the position could take you months
to execute. So, that doesn’t make sense, either. So, how do you execute without impacting the
market? Well, if there was real liquidity, and not
just this, I don’t want to say that all liquidity is Phantom liquidity. But if there’s PS liquidity that’s not real
wasn’t in the market, I honestly think you could take 30% of the ATV out of the market,
lower it 7 billion by 30%. And if it’s just real liquidity, it’d be easier
to trade. TYLER NEVILLE: Yeah. Can we switch directions and basically go
to the exchanges? And talk about how they are the main- they’re
one of three owners of the entire ecosystem. And what their incentives are. RONAN RYAN: Yeah. We’ve publicly gone after their incentives
recently. And I will say, we’ve had this view forever. So, this is not like a changing thing at IEX
from day one. Notably, what I’m talking about first is like
market data and charging for technology. So, from day one, from our days as a dark
pool, ATS, we’ve never charged for any connectivity to IEX, we don’t believe in that. We don’t believe in paying rebates for order
flow. The current exchanges, and what’s been great
about this recently, as we put out a white paper on IEX’s costs to provide market data,
the entire brokerage community was very happy. Because if you talk to brokers, and you ask
them over the years, their technology fees have gone like this, like astronomical, 700%. Our fees that we pay the exchanges since 2013
have gone up already 400%. So, you have these brokers constantly- you’re
a broker, you’re paid on a variable basis, meaning you’re paid on a per share basis. But at the beginning of the month, you have
to write a check to all these exchanges for a cross connect spin port, flux capacitor,
collocation, all these things in this environment, which a lot of people know who are watching
this, in this reg NMS environment, the brokers are required to connect to all these exchanges. So, you have three families, like you said,
but the three families own 12 separate venues, and you have to pay to connect to each of
these venues. And each of these venues have their market
data. So, that’s why you don’t see consolidation
like you do in most industries. If someone buys three other competitors, maybe
they would consolidate them, you don’t see that in the exchange landscape. So, I think when with technology fees going
like this, and the average daily volume like we discussed earlier going down, it’s harder
for brokers to make money. And there’s been some buy side pressure to
lower the commission rate. And all in all, you lower the commission rate
to such a level, the fees are a level, average daily volumes down. And then people are just like stunned that
a broker might try and get a rebate from an exchange instead of paying a take fee. And I think the greatest example is if you
look at NASDAQ, tier one, tape A names, it cost you 30 mils to take liquidity on that
venue and the rebates, 29 and a half mils. So, it’s a 59 and a half mil swing when you
make our take on that particular venue. When the average low touch execution buy side
probably play the sell side, somewhere between 50 mils and 75 mils. So, my thing and I’ve said this to the buy
side, this is not an attack on the buy side at all. I’m saying if post the transaction fee pilot,
which is basically testing the band of rebates, or lowering the take fee, the most an exchange
can charge to take is 30 mils, they’re lowering it in one of their buckets down to 10 mils. If the determinant at the end of this pilot
is that the exchanges can’t charge 30 mils to take any more, the max they can charge
is 10, the buy side should consider not just automatically lowering your commission rate
by 20 mils. And I think let the dust settle and see how
brokers can make more money in an environment like that. And that’s been something, obviously, as I
say it, I can see why the brokers are supportive of that message. But in fairness to them, because we are in
effect, we have a broker dealer for our router here. And we have to connect to these exchanges. And like I said, on any given month, they
can charge us whatever the heck they want for anything. TYLER NEVILLE: So, recap high level. They’re really generating, as trading volume
goes down the actual transaction volume, the money you’re making off of buying and selling
stock is down. And astronomically, the actual fees they’re
charging just to connect to the data, which is the Phantom liquidity a lot of times because
of these rebates. It’s incentivizing trades that aren’t long
term investors, it’s very short term, fast. So, they’re making more money on the data
feeds than actual trading. RONAN RYAN: Oh, 100%. TYLER NEVILLE: And you’re trying to essentially
ARB that in a way where you want to be more in line with the long term investor. RONAN RYAN: Yeah. We want trading to be- look, we’re not putting
the genie back in the bottle, we trade, and we match. Our delay is a startling 350 millions of a
second like, 1/1000, the blink of an eye, whoever measures this shit, like we are not
slow. However, we’re not slow comparatively. But if you look at an exchange, I just told
you, NASDAQ, take fee is 30 mils, rebate is 29 and a half. They’re capturing a half a mil per share,
whereas IEX, the only money we make is when you trade. So, it’s a novel idea. Like I said, we’re not putting the genie back
in the bottle, but we’re taking exchanges back to what they used to be, pay us in a
variable basis. Broker, you’re the client of the exchange,
you’re paid on a per share basis, pay the exchange on a per share basis, run your business
appropriately so that you can make some money in there. And the easiest way to do that if you know
concretely what your cost per share is, and that’s what IEX is. We charge nine mils if you trade with us non-displayed,
three mils, if you trade with us displayed. You can fit our pricing model, if you will,
in a tweet. Whereas if you look at the New York Stock
Exchange, or NASDAQ’s pricing, it’s reams of paper, you have to give a shit about it. And you have to even understand it. It just makes no sense. TYLER NEVILLE: Yep. I am with you there. Now, block liquidity and dark liquidity. Do you see more orders coming your way in
that sense? RONAN RYAN: More orders- you’re more likely,
obviously, to get a block fill if it’s a dark fill. No one in this type of environment is looking
to display in massive size any interest whether they’re a seller or a buyer. What I would say is we, IEX, are still a continuous
market. We’re a stock exchange so the percentage of
block trading is not near the level where you would see on a venue like a liquid net,
for example. However, we do have quite a lot of block train. So, what we do is we call, interacting with
IEX one of the ways in which the buy side does so is called direct resting and just
in English, that means you give the order to the broker, the broker does nothing with
it. No algorithms, no secret sauce, just places
on IEX. And if you can leave your order on IEX for
three minutes or greater, 10,000 shares or greater, our block percentage and I’m not
cherry picking this, this is for all years, 2017 and 2018, our block percentage is something
like 45%. It’s amazingly high. We joke about it sometimes and go to a buy
side trader in your seat and says what if I told you, you could get IPOVs, something
like unlimited percent of volume of 20% plus block volume of 45%. We’re barely moving the stock. You would think it’s a secret algo. A secret algo is just resting it in one place. One place that’s designed for the buy side
with mechanisms in place to protect you. And it’s overly simple because sometimes when
you tell people- and it does sound self-serving, oh, just rest in IEX. But the truth is, if you rest it in IEX, and
there’s hundreds of thousands of orders now of data to prove this year over a year, that
is the outcome on IEX. You can participate at a high percentage in
the 20% range, high percentage of block and barely move the stock. And it is the holy grail of what someone in
your previous seat would have liked to see. TYLER NEVILLE: And I think they’re slowly
catching on to that, the buy side, where they realize that the mandates of TCA and all these
TCAs, transaction cost analysis, where they put all these funky subjective statistics
on your order, which is complete nonsense, in my opinion. Where I would rather get- if I was at a giant
shop, a million shares of liquidity in one day and not trading that stock over a five-day
period. And I think that there’s a transition happening
because a lot of the traders that sit in those seats now are under 30 years old, and they
never knew market structure before. So, they’re afraid to actually block trade
or show big liquidity, whereas it’s probably enhancing your alpha on a fundamental basis
if you do those types of trades. RONAN RYAN: Yeah, we’re seeing some things
changed though now. So, I will tell you, in- you would have experienced
this, over the past 10 years with all the dark pools, all these venues, a particular
broker might have to connect to them all, because a lot of times people on the buy side
and people on the sell side thought the only way to access all the liquidity and the best
way to source it is to connect to all of these venues. And what happens is orders started to get
further sliced up, because you send in an order to buy 10,000 shares, and your broker
nails machine gunning it to 20 different platforms. And then machine gunning in and of itself
lends itself to information leakage, and it depends, then you have to figure out what
each platform is doing what it is. That platform in turn, IOYing it meaning indicating
your interest out to another platform. And a lot of times, people say, I put an order
in this algo. The machine guns out, I get nothing done and
the price moves. I’m like, how is that possible? So, now we’ve seen in the past 12 months,
people are experimenting with lowering the number of venues that they rest an order in
or that they connect to and that it’s okay, because it used to be this misnomer best X. If I’m going to get the best X, I got to be
connected to everything, I got to find it because I’m going to miss it if I’m not. Whereas anyone with a sensical head and is
watching this recognizes that liquidity is like transitory. So, nothing that you see in these 10 venues
is necessarily unique to each of those 10 venues. It’s just your interest to buy or sell, being
sliced up and represented in all these venues. If you can find one venue, one venue that
everybody’s connected to, doesn’t necessarily have to be IEX, by the way, it’s just we’ve
put mechanisms in place, like our discretionary paying order type, which is very popular,
and the fact that we have very little movement post trade on these massive orders. But less venue is actually- it’s funny saying
it, but less is more, and the data is proving that. TYLER NEVILLE: And the SEC chairman have gone
out and said he’s analyzing that, the order protection rule, I believe, you talked about
where that doesn’t necessarily mean best X to see every single venues flow. Whereas you might see a block liquidity in
IEX and you don’t actually have to trade on the superfluous ATSes. RONAN RYAN: Exactly. And the order protection rule, I guess what
it helps you build from a broker, or any or like even our view at IEX, how do we know
that we’re printing someone at the right price? So, we do a lot of mid-point trades. Midpoint trades is just the mid between the
bid and the offer. How do you know what the prevailing bid and
offer is? That’s the NBBO. That’s the order protection rule. I think it’s a good rule and that you can’t
print someone outside of that meaning you’re not buying stock on behalf of your client,
far more expensive than you could if you just sent the order to another venue. So, it’s a difficult one, the order protection
rule is- if you think about it when they came up with the idea, it’s a great idea. Don’t trade at an inferior price. If there’s an equal to or better price somewhere
else, why would you trade an inferior price? But in a market where now we’re measuring
things and billionth of a second, what the real price is, is very hard to ascertain. So, I think what you find with the SEC now-
and not on any specific thing that they’re working at, but I think there’s a far more
progressive approach to market structure. And I think they’re looking at things the
right way. Not that they looked at things the wrong way
before, much like the buy side and the sell side and the PMs were all caught unawares. Same thing with the regulators as well. This is very, very complex. And you need people like Jay Clayton, Brett
Redfern, former market structure guy, former trader guy, you need people who’ve been in
the trenches, who’ve seen what’s going on, to step in and try and police what’s going
on as well. And we’ve been really, really encouraged I
think, as has most of the brokerage community with the current regime, I say in a positive
way, and what they’re looking to do. Our pilot, like, they want to pilot, something
that’s been debated for like 10 years. People have had like a, it’s like, right and
left, rebates are good, rebates are bad. TYLER NEVILLE: You’re talking about the transaction? Which is a very high level, essentially, what
they’re trying to do is take a certain subsector of the market. And just nullify the rebates and see what
happens. RONAN RYAN: Yeah. Just run a pilot on 730 names TYLER NEVILLE:
And what happened was the exchanges ended up suing the SEC. And this is happening right now. RONAN RYAN: It’s happening right now. Yeah, it was remarkable. I think within 48 hours of each other, the
NASDAQ family, the NYSE:ICE family, the CBOE bets family. So, 12 of the 13 exchanges, IEX is the 13th
, 12 of them, sued the SEC to not allow the pilot to go through. To not allow a pilot, it’s not like the rule
came in saying you can’t ban rebates. This was a pilot to test not paying any rebates
on a subset of 730 symbols for one year. TYLER NEVILLE: And theoretically, if that
happens, half of their flow that’s on trading back and forth. So, short term, HFT guys would essentially
become profitless. RONAN RYAN: It’s hard to know the exact percentages. I’ll tell you from even talking to like HFT
firms recently, profitability per share for a lot of their strategies. This is not IEX, this is directly from clients,
telling us a single digit mils. So, if you’re used to getting a 29 mil rebate,
and you can’t get any rebate, or they lower the rebate that the most you can charge to
take is 10. So, maybe it’s a nine mil rebate, it changes
the model completely. What I would say is this, is the current exchanges
wouldn’t have such a reaction to a pilot to the point that they sue their regulators like
the E and the SEC is exchanges, they regulate exchanges, and they sue them, you wouldn’t
possibly contemplate doing that unless you thought there was a bad outcome in the future. So, what we thought was interesting is that
the SEC did stay the pilot, but they’ve gone ahead with the data gathering. So, what that means is the pilot was proposed
to do six months data gathering, 12-month pilot and six months data gathering post the
pilot, so all in two years, while the courts, I guess adjudicate the exchanges lawsuit against
the SEC. The data gathering starts July 1st. So, it doesn’t delay the two-year time cycle
of the pilot, unless within six months of July 1st, it’s not rectified as to whether
the pilot can commence. We’re pretty confident. TYLER NEVILLE: And you’re saying, just in
that little change in regulation, you’re seeing the benefits of flow coming towards you. You’ve had your best month last month in May. RONAN RYAN: Yeah, yeah. I don’t fully know. What we’ve done is we’ve done a lot of, I
guess I’ll call it more consultative approach with the brokers than the typical exchanges
do, and this is feedback we’re getting from the brokers again, it’s not IEX surmising
it. We’ve been looking and helping them to tweak
their algos to one, better use IEX just in general. Help them look at the data. And we’ve made some suggestions. So, some brokers have grabbed the bull by
the horns, and configured algos specifically designed to better interact with IEX and that’s
helped their market share. I do think things like the transaction fee
pilot, when it goes into place, if you think about it, like I said with market data, we’ve
never charged for market data, we’ve never charged for any of these fees. Again, before we even left our jobs at RBC
to start IEX not even knowing what running an exchange was, we were adamant about not
paying rebates. If you’re operating as an agent of your client,
and you’re sending an order to a venue to get a rebate back that you don’t, in fact,
give back to your client, at minimum, you have to admit there can be a perception of
a conflict of interest, whether you’re doing anything right or wrong, isn’t it a better
business model to just charge? Like just charge your client and pay the exchange
less than you’re charging your client. It’s that easy. And that’s what trading has been for basically
hundreds of years. There’s no reason just because we’re trading
at super ultra-high speed like the market is more efficient. Of course, it’s more efficient than it was. TYLER NEVILLE: It is a retail investor. Because if you’re buying 100 shares, it’s
actually great. It doesn’t matter. But when there’s so much money tied up in
401Ks. And there’s these giant aircraft carriers
of assets. They’re actually the mom and pop in North
Dakota. And they’re getting affected by it by the
401K. They just don’t realize it. RONAN RYAN: Yep. And that’s why I always say, you can love
or hate IEX, we built this for the institutional investor, because in the end, the institutional
investor represents millions, hundreds of millions of moms and pops. And it’s moms and pops not slinging around
a few thousand dollars in a more gambling type fashion. It’s their pensions, it’s their retirement. And a big pension firm or a big mutual fund
entering the market to buy like the big- to use your analogy, the aircraft have an order
that represents thousands, if not millions, of mom and pops. And those are difficult orders to interact
and to execute in this market because of the complexity. And because, look, it’s a capitalist society
is a capitalist market, and that’s okay. But if you can ascertain, there’s a big buyer
coming into the market. And the more certainty you have that there’s
a big buyer coming to the market, and it’s completely legal for you to do so. Why wouldn’t you? Why wouldn’t you try and get ahead of that
order? Buy up inventory and sell it back for more? Why wouldn’t you do that? So, for people to debate that that’s not what
they do is absolute, complete and utter nonsense. TYLER NEVILLE: It really is based off the
exchange is what I’m saying. If they’re charging so much money for market
data and connectivity, then you really need assets at scale. So, like you have to go, you’ll charge a small
fee on an ETF, and then you have the assets grow. And that’s how they can battle against the
fees that they’re paying. And I think hedge funds are actually, if you
really go to the meat and bones of it, they’re actually underperforming, more so for market
structure than they realize because that two and 20 works great. But now, ETFs are underpricing them. And it’s this constant, like Amazon effect,
where the fees just go lower and lower. But something has to break. And I think it’s going to probably break on
the exchange side. RONAN RYAN: Yeah, no, I agree with you completely. Again, we have a lot of clients that are hedge
funds, as well. And a lot of those folks are entering the
Titanics into the market. But you’re right. Their commission, if you will, or their rates
that they’re paid have been compressed to such a level. And then they have a bad year. And then the marketing of Passover, how did
XYZ hedge fund perform versus the index? And then also, not so great as of late. And that lends itself to the story. TYLER NEVILLE: Hedge funds were thought of
as these really fast moving jet fighter pilots. But they’re actually I think what’s happening
is, if you step back is liquidity is not there. So, they grew these assets to be a billion
dollar fund. And then they’re trying to navigate gate this
tiny river of liquidity. And it’s not possible to do. It takes a human a lot of times to trade a
block where like I’m going to sit here in this dark pool or call somebody up and trade
a block. And that’s happening less and less, because
there’s only one person manning the ship. And a lot of these hedge funds. RONAN RYAN: Scary. We recognize when we came out, we had to be
aggressive in order to get brokers to connect to us. We were funded by the buy side. Exchanges don’t normally and still don’t talk
to the buy side, like the way that IEX does. And that can rub people sometimes the wrong
way. But I think when you look at some of the things
that we’ve worked on with the brokerage community over the last 12 to 18 months, I think people
are seeing that the potential wave of the future is work with an exchange that is aligned
and aligned in terms of you’re paid on a per share basis, pay them on a per share basis. Don’t worry about anything else. And we put our money where our mouth is because
putting out a white paper, showing our exact costs, chastising our competitor exchanges
for how much they have marked it up. It’d be really a difficult thing for us to
all of a sudden in a couple of years, start charging people obscene fees for like a cable. TYLER NEVILLE: Which you made a great commercial
on YouTube. SPEAKER 1: This cable looks ordinary, right? And it is. But plug it into your trading systems and
whoa, you open a whole new world of shockingly basic access to those fusty old exchanges
and the data they distribute. RONAN RYAN: I have to say what was fun and
in fairness to the exchanges, I think people who work at the other exchanges, people we
know had given us a pat on the back and said that was pretty funny. SPEAKER 1: Kiss that cable. The only cable you’re ever going to need. This cable absorbs all your extra capital. RONAN RYAN: And sometimes, they need some
levity in this business. Because we are talking about like microseconds
and cable length and all this nonsense. If you step back, and it’s like, someone said
once to me like millisecond, microsecond, hold on a second, that’s what we should be
doing. TYLER NEVILLE: So, can you talk about how
exchanges make money in more high level like what percentages from market data? What percentages from listing? What percentages from trading costs? And when you’re trying to do to grow? RONAN RYAN: It’s a hard thing to ascertain. And maybe it’s purposely done. So, I’ll explain it in this way. So, when you look at like NASDAQ and the New
York Stock Exchange, I think roughly 35%, 40% of the revenue comes from charging listings
fees, like they have several thousand companies listing on them. Top tier on NASDAQ, I believe is 156,000 a
year, top tier on the New York Stock Exchange is 500,000 a year. So, it’s something like in the 400-400. Just to list. Just to have that badge that you’re listed
on the New York Stock Exchange or NASDAQ. Yeah, it’s an obscene amount of money. Then roughly 60- so that’s like 35%. And I think around 10% comes from trading. And by that I mean, because sometimes, the
way the exchanges will say it is oh, well, we brought in this much revenue in trading,
but they don’t net out the rebates. So, if you make a billion and you rebate,
900 million, you have made 100 million in trading, you don’t flash that as a billion
in trading. So, if you look at it that way, which is the
intellectually honest way, it’s roughly 10%. And the rest of it is all comprised of technology,
collocation, market data, all these things. But what I would say and the reason why I
caveat it this way is it’s very hard to stitch that together when you look at their public
filings, because the way things are labeled or named, very, very difficult to break it
up. TYLER NEVILLE: Do you think that has stifled
innovation in a way where you have such a high listing cost and it’s almost like they’re
trying to churn out fees from their investors and people listing, were like, that’s why
you see all these private companies staying private longer? And how are you guys trying to battle that? RONAN RYAN: Yeah, I don’t. So, I’ll tell you, when we meet with companies
around listings, most always, they’ll say it really has nothing to do with the fee. So, I don’t think that people are not going
public because of the egregious costs that NYSE or NASDAQ might levy on them. I think they’re more concerned maybe to the
extent that they look at market structure on why stocks are slinging all over the place? What’s the value? People are scared to go public. They don’t want the quarterly scrutiny, or
even those companies that are public, I’ll tell you the thing that we find most interesting
when we meet with existing public companies, they can’t understand why they look at their
holdings, they call the Wellington’s Vanguard, whomever are in their holdings list in Bloomberg,
and they’ll say, yeah, we haven’t turned you over at all. Well, then, who’s turning over this float? Who’s trading all of this? So, there’s a lot of liquidity just churning
around the market. And that frustrates them. And I remember I met with the CEO of a public
company, and he’s like, look, I’ll come in and my stock price is jumping around all over
the place. There’s no news. There’s no earnings, there’s no nothing, there’s
no reason for it. And when I call my existing listings exchange,
they have no answer for me. Or they’ll give me some like BS canned answer,
like, oh, a hedge fund is shorting your name. So, what we’ve tried to do or what we hope
to do is in our listings business is bring more analytical approach to those type of
questions. And we’re looking in that. What we did is we first started trading as
an ATS in October 25th , 2013. From that day forward, we’ve sequenced every
single market data message. And what that means in English is, client
could come to us and say, on whatever day it is, June 10th of 2016, three years ago,
I had this strange experience in my stock XYZ. We could go back to June 10th of 2016 in symbol
XYZ at 1:38 in the afternoon, and then we could do some analysis on what we think we
happen in the market. And we have all of that information. So, we’ve done that for some companies who
we’re talking to about listing on IEX, and companies have told us- haven’t switched yet,
but we’re staying on them. They’ve told us, listen, I’ve been asking
my current listing exchange this for like 18 months, and in a 15-minute conversation
with you guys, you’ve given us more answers. And we can follow up like, also, what’s interesting
in this industry, where the public companies are not afraid to ask a question. I’ve always found that- maybe because I came
to Wall Street late in life, people don’t want to- within a group, say I don’t even
understand what that market means or anything like that. But a public company will go listen, fella,
can you speak in English, and tell me what this means. And we’re happy to do that, if we have to
get down to the level of explaining what bid and offer is. And what was interesting is you had made a
comment there’s less traders on Wall Street, what I have noticed that I think is really
encouraging is a lot of ex-sell side traders have actually migrated over and now, they’re
working as Investor Relations Officers at these public companies. So, even the difference between like four
years ago when we’d meet with these companies, and now, you meet with them, they’re plunking
up like a Bloomberg and they’re looking at holdings, and they can really understand this
data, they really want to know what’s going on. And I’m not picking on any particular IRO. But I will tell you, I’ve met with public
companies that are listed on whether it’s NYSE or NASDAQ and they didn’t even realize
that they actually can trade anywhere else. Like within the last few years, everyone’s
like, that’s not okay not to know. Any IROs out out there, that’s not okay not
to know. And I think you need more progressive people
within that job. And I’ve always felt like the buy side were
slightly behind the curve on the market structure knowledge relative to the sell side, sell
side were behind relative to the HFT sell side and behind the buy side or like the issuer
community and all of that now is catching up, which I think is a good thing, because
the only thing you can do to tort and understand complexity is to get a grip on what’s going
on. TYLER NEVILLE: Why don’t we take a look at
your magic shoe box that I’ve heard so much about? RONAN RYAN: This is one of the original four
magic shoe boxes. So, when we say magic shoe box, what this
is, is, this is fiber optic cable coil that’s 61.235 kilometers of fiber optic cable. And we didn’t just do this to be sadists,
we did this because this introduces latency, introduces distance. So, what we wanted to do with our market is
slow things down a little bit. And by slow it down, we slow it down 350 microseconds,
350 millionth of a second. And the least subjective way to do it is to
introduce latency, introduce distance. You can try and do it through software. But that can be subjective, you can forget
to program someone’s access port. And now all of a sudden, they’re trading faster
than everybody else. So, all we did is we literally set everyone
and what this cabinet here depicts is out in New Jersey, where the trading happens,
we literally have hundreds and hundreds of those cables. Those are called cross connects, that’s brokers
connecting into our platform. They come into that network switches, it was
the second box, and then they go into that coil. So, you go in one side, you go around these
three schools. And what this means is whether it’s market
open on a hectic day or middle of the day, Easter Sunday, it’s always 350 microseconds. It’s 100% accurate. No fluctuation whatsoever. I actually took one of the four, these are
now obsolete, we have new ones in, and I made a coffee table out of it and I like to tell
people at home like if you see there, that’s our trading so far today. So, at 2:30 today, we’ve already done $6.62
billion notionally traded, so I like to tell people that billions of dollars go through
my coffee table every day. Someone gives a shit. I enjoy it. The trades all come in through those cables
into the speed bump. So, we saw the magic shoe box. TYLER NEVILLE: 50 million orders. RONAN RYAN: Yep. And then it goes through and that’s supposed
to pick the coil. Then it takes it to the client gateways. And this is I was mentioning, we sequence
every single message. So, every single message on all markets, we
have a time sync, so we can play back the market from our first day of trading back
to October 2013 ’til 2:30, whatever time it is today, we can tell you exactly what happened
in any symbol in any market.

11 thoughts on “The Perverse Incentives of Stock Exchanges and Their Data Monopoly (w/ Ronan Ryan)

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  2. This is sort of an interesting discussion. Smart guy… but nit relevant tomorrow’s market of crypto assets and distributed token exchanges.

    It would be interesting to hear this chap speak about exchanges and tokenization of stocks.

  3. Fascinating! Speculation that has nothing to do with real economy is a huge and super high tech industry. Shocked to see how many people try to make money without actually producing anything of value 😁 I guess they will eat nanosecond when we stop hauling grain

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