April 05, 2019 Speedbumps Redux. Sort Of Larry Tabb TABB Group Follow | Profile | More Share ICE’s recently proposed speedbump for silver and gold futures contracts has ignited the latest market fight over speedbumps. But this isn’t the same IEX-type speedbump that caused an all-out ruckus in the US equities market. ICE’s proposed asymmetrical speedbump could potentially have an even more damaging impact on price discovery and liquidity, altering the competitive balance in the market and tipping an otherwise level playing field in favor of sophisticated liquidity providers over slower traders and liquidity takers, says TABB Group founder and research chairman Larry Tabb. There is a new bump on the Street. This isn’t the same IEX-type speedbump that caused an all-out ruckus in the US equities market. This new fight is over the ICE’s recently proposed asymmetrical speedbump for silver and gold futures contracts, a mechanism that could potentially have an even more damaging impact on price discovery and liquidity. Unlike the IEX speedbump, which applies a 350-microsecond delay on all orders (liquidity providers and takers), the ICE futures speedbump would apply a significantly longer 3-millisecond delay only to liquidity taking (marketable) orders. While I am not a fan of symmetric speedbumps (see: “As an Exchange, IEX Wouldn’t Be Fair, Simple or Transparent”), the impacts of an asymmetric speedbump are far more significant. The ICE speedbump enables market makers, or firms that can finely manage limit orders, to look back over the last 3 milliseconds and duck out of the way of an adverse price movement. As I mentioned in a previous commentary – “EDGA, the Hot Tub Time Machine of Stock Trading” – the proposed speedbump is an automated fade that systematically moves orders out of the way during times when the price of an asset is fluctuating. This enables traders to post overly aggressive quotes that they may not actually honor, particularly during times of market volatility. This proposed speedbump would change the nature of taking displayed liquidity. During the price discovery process, trading activity accelerates when one or more traders believe that the current price is no longer accurate. During price discovery, one or more firms will push the price one way, while others push back. This price discovery process continues until consensus is reached. With an asymmetric speedbump, these price changes will most likely become more aggressive. Liquidity providers will see market turmoil occurring on other, non-delayed markets and have 3 milliseconds to pull their orders on ICE, or more likely, reposition their orders at a more adverse (for the liquidity demander) price point. This type of mechanism clearly reinforces one trading style over another and alters the competitive balance in the market. This mechanism tips an otherwise level playing field toward a structure that favors liquidity providers over takers and benefits the use of limit orders and quotes by sophisticated traders over both non-sophisticated traders and those using marketable orders. It enables these sophisticated liquidity providers to put up overly aggressive prices on ICE and leverage the real-time price discovery of non-delayed markets in order to know when to pull the ICE orders to avoid unfavorable executions. This will inevitably increase the sophisticated trader’s profits to the detriment of other market participants. An Anti-Incentive Some may call this speedbump an incentive to provide liquidity; however, unlike a rebate, which incentivizes traders to post passive liquidity that improves the actual price of an executed order, an asymmetric speedbump only benefits sophisticated firms that can alter their passively placed liquidity in less than 3 milliseconds (0.003 seconds) and actually harms the price discovery process. An asymmetric bump, by facilitating the display of real-time pricing but subsequently delaying the execution of marketable orders, enables sophisticated liquidity providers to fade out of the way of potentially disadvantageous executions, leaving incoming orders either to be filled at an adverse price or deposited back at the trader’s doorstep, unfilled, 3 milliseconds later, at which time the trader is stuck with an unfilled order that needs to be resubmitted into a market where the price has moved adversely. So why is ICE doing this? First, ICE initially announced that it purportedly intends to use the asymmetric speedbump only for silver and gold contracts, where it does not have significant market share. However, ICE’s actual rule filing (if approved) would authorize ICE to apply this type of speedbump to all its markets and vary the speed delay at its discretion. More worryingly, it would enable this mechanism to spread to other U.S. futures exchanges and contracts, much like the approval of the IEX speedbump resulted in a proliferation of similar proposals in the equities markets several years ago. [Related: “Speedbump Markets: Don’t Get Burned”] Second, ICE seems to be trying to introduce competition with the CME by offering liquidity providers a significant advantage. While promoting competition is laudable in the historically vertically integrated futures markets, where contract IP, trading and clearing occur within the same entity, I don’t believe that altering the historical fairness between liquidity providers and takers by offering a look-back option to professional liquidity providers while harming half the market is an appropriate competitive response. In addition, the competition angle is also a flawed argument – if this speedbump succeeds, why wouldn’t the CME, Eurex, or some other exchange just offer a similar speedbump? By authorizing this rule, the CFTC would be sanctioning a mechanism for sophisticated market participants to take advantage of slower traders and liquidity takers. Conclusion While I understand the difficulties of entering a new market, developing liquidity for new products, and creating liquidity provider incentives, I don’t believe that the CFTC should give the ICE carte blanche to offer an asymmetric speedbump that leverages the price discovery process developed by a competitive exchange to favor sophisticated liquidity providers while impairing price discovery. We should not be in the business of condoning rules that create phantom liquidity that is likely to fade when prices transition. While I would love to be a professional trader in a market where I have an institutional advantage and a guaranteed profit, I am not sure that the downsides inherent in asymmetric speedbumps – such as obfuscating price discovery and decreasing execution quality for many market participants – are in the best interests of futures markets or their users.