WEBVTT - Larry Tabb Sees Problems With Trading Prices and IEX (Audio) 0:00:03.200 --> 0:00:06.560 Global business news twenty four hours a day. If Bloomberg 0:00:06.640 --> 0:00:09.720 dot Com, the radio plus mobile and on your radio. 0:00:10.000 --> 0:00:14.520 This is a Bloomberg Business Flash from Bloomberg World Headquarters. 0:00:14.560 --> 0:00:18.279 I'm Charlie Pellett's stocks are moving higher. We've got the 0:00:18.480 --> 0:00:22.479 SMP five hundred index heading for its strongest gain in 0:00:22.760 --> 0:00:25.840 a month. UK citizens voting today and a referendum on 0:00:25.880 --> 0:00:30.200 the country's membership of the European Union. 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NAS 0:00:52.960 --> 0:00:55.640 stack up sixty eight, a gain of one point four percent. 0:00:56.080 --> 0:00:58.720 The ten year down fifteen thirty seconds, the yield one 0:00:58.760 --> 0:01:03.360 point seven three percent, Gold down six to twelve sixty 0:01:03.400 --> 0:01:06.959 three drop a point five and crude oil West Texas 0:01:07.000 --> 0:01:10.160 Intermediate of one point nine percent fifty oh seven for 0:01:10.160 --> 0:01:13.440 a barrel of West Texas Intermediate. That is a game 0:01:13.480 --> 0:01:18.520 of cents. I'm Charlie Palla. That's a Bloomberg business flash. 0:01:18.760 --> 0:01:21.760 You're listening to Taking Stock with Kathleen Hayes and Pim 0:01:21.880 --> 0:01:26.360 Fox on Bloomberg Radio. The I e X. If you 0:01:26.520 --> 0:01:30.000 go to the Investors Exchange website, the i X S 0:01:30.680 --> 0:01:32.440 I e X I should say it says it's the 0:01:32.480 --> 0:01:35.959 first equity trading venue owned exclusively by a consortium of 0:01:36.000 --> 0:01:40.720 by side investors, including mutual funds, heads funds, family offices. 0:01:41.040 --> 0:01:44.680 In fact, Bread katsu Yama, the I e X co founder, 0:01:44.800 --> 0:01:48.280 says this new stock exchange will make people safer. It's 0:01:48.320 --> 0:01:51.440 now been approved with National as a national exchange. But 0:01:51.480 --> 0:01:54.600 our next guest says he's not sure this is such 0:01:54.600 --> 0:01:57.640 a good thing for investors. Let's ask him why we're 0:01:57.880 --> 0:02:00.960 welcoming now. Larry Tab, CEO and whole founder of the 0:02:01.000 --> 0:02:04.080 Tab Group based here in New York. Larry, thanks for 0:02:04.120 --> 0:02:07.600 taking time for taking stock. Al Hi, Kathleen, thanks for 0:02:07.640 --> 0:02:11.120 having me so in your words, explain to our listeners 0:02:11.360 --> 0:02:14.360 what the I I e X was and remind is 0:02:14.840 --> 0:02:17.919 why it was found in the first place. Well, well, 0:02:17.960 --> 0:02:20.200 first of all, hats off to those guys say there 0:02:20.280 --> 0:02:26.240 now or will be a fully fledged exchange good for them. UM. 0:02:26.520 --> 0:02:29.480 I X have founded kind of on the heels of 0:02:29.480 --> 0:02:33.400 of Michael Lewis's Flash Boys book that really talked about 0:02:33.880 --> 0:02:37.880 latency arbitrage and in picking off investors and the whole 0:02:37.919 --> 0:02:41.000 idea of that UM you know, the markets were not 0:02:41.080 --> 0:02:44.320 so safe for investors. I won't use the R word 0:02:44.360 --> 0:02:48.560 but because I don't believe in it. But but that's 0:02:48.600 --> 0:02:51.400 kind of the premise that I e x UH was 0:02:51.480 --> 0:02:56.320 born under. And UH. One of the key foundations of 0:02:56.400 --> 0:02:59.760 their platform is a speed bump, basically a very short 0:03:00.040 --> 0:03:03.919 speed bump three and fifty microseconds each way, basically seven 0:03:04.120 --> 0:03:10.680 microseconds in and out UH to ensure that that UM 0:03:11.000 --> 0:03:16.600 UH high frequency traders don't pick off limit orders and 0:03:16.600 --> 0:03:19.640 and to a certain extent, UM it's a good premise. 0:03:19.960 --> 0:03:24.920 It works well. They've gained share UM institutional investors tend 0:03:24.960 --> 0:03:29.800 to like them. But to a certain extent, the current 0:03:29.840 --> 0:03:35.440 market structure is has what they call out of protection 0:03:35.520 --> 0:03:40.760 rules of forced exchanges to route UM to the various 0:03:40.840 --> 0:03:45.040 exchanges and the speed bump that i X has and 0:03:45.440 --> 0:03:48.440 what I'm assuming will be multiple speed bumps. If I 0:03:48.600 --> 0:03:51.320 e X is successful, I think you'll wind up seeing 0:03:51.360 --> 0:03:55.640 multiple speed bumps and variations. Just to certain extent, the 0:03:55.680 --> 0:03:58.760 speed bump makes it more difficult for machines to find 0:03:58.760 --> 0:04:02.120 what the right prices. So if you know one price 0:04:02.240 --> 0:04:05.800 is delayed um and everything else is in real time, 0:04:06.400 --> 0:04:09.160 you're kind of comparing apples to orange is um comparing 0:04:09.280 --> 0:04:14.480 the price of an asset the way it was microseconds 0:04:14.560 --> 0:04:19.400 to what what everybody else is displaying today? And while 0:04:19.440 --> 0:04:23.880 tiny microsoconds isn't a long time at all, machines thinking 0:04:24.240 --> 0:04:27.400 much quicker time frames these days. So it becomes really 0:04:27.960 --> 0:04:31.760 a bit challenging for the machines to find the right quote. 0:04:31.760 --> 0:04:36.320 And that would be even more especially true if multiple 0:04:36.360 --> 0:04:40.960 speed bumps are developed. Alarright, could you just step back 0:04:41.000 --> 0:04:44.480 for a second and explain how high frequency trading works 0:04:44.480 --> 0:04:47.240 in connection with picking off limit orders and what are 0:04:47.320 --> 0:04:50.000 limit orders for those that are not in the weeds 0:04:50.000 --> 0:04:53.640 with this, Yeah, limit order is is just you know, 0:04:53.680 --> 0:04:56.719 the desire to buy a product at a certain price. 0:04:56.760 --> 0:05:00.680 So you see a quote in the marketplace, um, and 0:05:01.240 --> 0:05:04.000 the quotes that you see I'll buy a ten and 0:05:04.040 --> 0:05:07.120 sell it ten on one, those are basically limit orders 0:05:07.200 --> 0:05:13.760 or quotes UM, and so uh, generally, what high frequency 0:05:13.760 --> 0:05:18.039 traders it's harder to find high frequency traders, but a 0:05:18.120 --> 0:05:20.880 lot of the quotes are created by market makers which 0:05:20.920 --> 0:05:25.200 tend to use high frequency trading infrastructure, are very fast 0:05:25.240 --> 0:05:30.880 infrastructure to quote because um, when they're managing quotes, you 0:05:30.920 --> 0:05:33.760 know they can there there are twelve and soon to 0:05:33.800 --> 0:05:37.640 be thirteen exchanges and so um to make sure that 0:05:37.680 --> 0:05:41.320 their quotes are you know, precisely on target. They have 0:05:41.400 --> 0:05:46.040 to basically manage them very closely. And so if they're 0:05:46.040 --> 0:05:50.360 a bit slow on updating that quote, another person with 0:05:50.480 --> 0:05:54.480 very fast technology can come in and take out that price. 0:05:54.680 --> 0:05:57.159 It possibly the wrong price that they are, a price 0:05:57.240 --> 0:06:00.760 that they didn't want to really trade at. So it's 0:06:00.760 --> 0:06:05.359 benefits James battling machines basically well, and of course we 0:06:05.440 --> 0:06:07.600 just had a guest on just in I guess the 0:06:07.680 --> 0:06:10.039 last couple of days. I believe it was John Manley 0:06:10.080 --> 0:06:14.279 Pam from from Wells Fargo and him asked him about 0:06:14.720 --> 0:06:16.920 high frequency trading and he said, at the end of 0:06:16.920 --> 0:06:18.680 the day for him is and he's the big big 0:06:18.680 --> 0:06:23.080 money manage the billions under management that this is or yeah, 0:06:23.120 --> 0:06:25.520 a lot of money, right, a quarter of a trillion. 0:06:25.600 --> 0:06:28.479 That is that at the end of the day, they 0:06:28.560 --> 0:06:31.920 manage money, they manage investments, and but at the end 0:06:31.920 --> 0:06:33.680 of the year, it probably doesn't make too much difference 0:06:33.680 --> 0:06:37.599 to their customers or their portfolios. The high frequency trading, 0:06:37.640 --> 0:06:41.440 So who does it potentially? Uh, Who's who's it bad for? 0:06:42.400 --> 0:06:46.800 The challenge becomes, well, first all it's it's becomes problematic 0:06:46.920 --> 0:06:49.719 for the larger investor because to certain extent the markets 0:06:49.720 --> 0:06:55.000 are geared towards smaller orders because of the fragmented exchange infrastructure, uh, 0:06:55.040 --> 0:06:57.880 and the very tight quotes and are the type prices 0:06:57.960 --> 0:07:03.280 and quick quote um A, once you get out of 0:07:03.520 --> 0:07:07.159 a certain range, it's supplying you know, the price moves. 0:07:07.320 --> 0:07:11.440 So if you're entering the market too strongly, it'll move 0:07:11.480 --> 0:07:14.160 the price. And that generally occurs with folks that are 0:07:14.200 --> 0:07:18.880 trading in larger size. So the second issue is that, 0:07:19.800 --> 0:07:24.840 um the people who turn over their portfolio have much 0:07:24.840 --> 0:07:26.880 more to lose. So if I'm you know, if I 0:07:27.280 --> 0:07:29.400 if I've got a quarter of a trillions, I've got 0:07:29.400 --> 0:07:34.360 two hundred fifty trillion, let's just say billion assets under management, 0:07:34.400 --> 0:07:42.320 and my turnovers once a year all the two fifty Basically, 0:07:42.320 --> 0:07:45.680 I'm only you know, my leakage to high frequency trading 0:07:45.720 --> 0:07:48.720 only occurs, you know, you know once a year when 0:07:48.720 --> 0:07:52.520 I trade. If I'm turning over my portfolio twice a year, 0:07:52.560 --> 0:07:58.040 then it happens twice monthly, twelve times daily, two fifty times. 0:07:58.520 --> 0:08:01.040 So clearly the people have the most to lose of 0:08:01.160 --> 0:08:04.840 the people with the highest amounts of turnover. And we're 0:08:04.840 --> 0:08:09.720 starting to see those guys invest in um much, you know, 0:08:10.120 --> 0:08:14.560 in more trading infrastructure and technology and data and the 0:08:14.600 --> 0:08:18.920 tools of services that helped them. But there is a 0:08:18.960 --> 0:08:22.840 need for something like i X for the larger investors 0:08:22.840 --> 0:08:25.520 so that they can come in and and trade in 0:08:25.600 --> 0:08:29.400 larger size. The problem is that you're holding one exchange 0:08:29.600 --> 0:08:32.720 to a very different standard than you're holding all the 0:08:32.720 --> 0:08:36.000 other exchanges. And if you wind up, you know, holding 0:08:36.000 --> 0:08:39.480 everybody at you know, at the same level you wind up, 0:08:39.640 --> 0:08:42.160 you know, you can wind up with a ten twelve 0:08:42.200 --> 0:08:45.400 different speed bumps, in which case it's really it becomes 0:08:45.520 --> 0:08:49.120 much more difficult to determine what's the right price because 0:08:49.240 --> 0:08:53.040 every every price you're seeing is somewhat delayed, and so 0:08:53.080 --> 0:08:55.520 it won't be the large exchanges that wind up doing this. 0:08:55.559 --> 0:08:59.280 It will be like there are twelve exchanges. It's to 0:08:59.320 --> 0:09:02.360 be thirteen. You might see like the bottom four or 0:09:02.400 --> 0:09:05.960 five you know, directly create speed bumps, and maybe the 0:09:05.960 --> 0:09:09.560 bigger ones, you know, um use some sort of order 0:09:09.600 --> 0:09:12.840 type that goes over speed bumps. So in Canada there's 0:09:12.880 --> 0:09:17.680 a market called Neo that that only certain order types 0:09:17.720 --> 0:09:20.560 go over the speed bump. It's only certain order types down. 0:09:21.200 --> 0:09:23.280 So you might see something like that occur on some 0:09:23.320 --> 0:09:25.920 of the bigger markets. So you know, you've got to 0:09:26.040 --> 0:09:28.200 you know, so that the question will be is what 0:09:28.320 --> 0:09:32.680 will the SEC allow if a number of copycaps come in? 0:09:33.400 --> 0:09:36.080 You know, how complicated does it get? How do I 0:09:36.160 --> 0:09:40.400 find the best price? And clearly if if if the 0:09:40.480 --> 0:09:45.120 pricing mechanism becomes more difficult to determine that you know, 0:09:45.160 --> 0:09:48.160 the you know, the smaller orders will will get hurt 0:09:48.480 --> 0:09:51.120 the most because spreads are wide and because you know, 0:09:51.120 --> 0:09:53.240 they're not really sure how type the price should be. 0:09:54.960 --> 0:09:59.000 Is this a response to market volatility? Not saying that's 0:09:59.000 --> 0:10:01.720 the correct response, but is that really what this is all? No, No, 0:10:01.880 --> 0:10:05.000 it really is actually a needed response. The problem is 0:10:05.040 --> 0:10:09.200 the is the seces Reaga n MS tries to create 0:10:09.440 --> 0:10:14.680 a youth MS. Reagan MS is the National Market Structure 0:10:14.800 --> 0:10:18.240 rules that were created two thousand five, two thousand and six, 0:10:18.480 --> 0:10:21.439 I think the implemented two thousand and seven UM that 0:10:21.600 --> 0:10:26.320 basically UH created something called order protection, which basically says, 0:10:26.320 --> 0:10:29.120 if you send your order to a market that doesn't 0:10:29.160 --> 0:10:32.319 have the best price, the exchange that routed to the 0:10:32.840 --> 0:10:35.880 market with the better price. And the problem with that 0:10:36.040 --> 0:10:39.680 is it creates a market structure that becomes very fast 0:10:40.520 --> 0:10:44.160 and and there's all this order routing and you know, 0:10:44.240 --> 0:10:47.559 going on behind so so right now on peak days 0:10:47.760 --> 0:10:50.400 there are millions of messages going on, very hard to manage, 0:10:51.120 --> 0:10:53.600 and to certain extent, it's all this interconnection that kind 0:10:53.600 --> 0:10:57.120 of gets challenged. Thanks for connecting the dots for us. 0:10:57.120 --> 0:10:59.680 So Larry tab is the chief executive and the founder 0:11:00.080 --> 0:11:04.520 of TAB Group, giving us some details about I e X, 0:11:04.679 --> 0:11:08.160 the new stock exchange. You're listening to taking Stock. I'm 0:11:08.200 --> 0:11:11.720 pim Fox my co host Kathleen Hayes. This is Bloomberg Radio.