IEX & the Re-Mutualization of Market Infrastructure
In light of our most recent post on misaligned motives in capital markets, I’ve been doing more thinking about Michael Lewis’s new book, Flash Boys, and the hero of that story, IEX.
In this context, I am less fascinated by the actions of high frequency traders than by the motives of the team who founded the new exchange. Many of those involved could have made more money on the sell side or by operating a more classic dark pool or exchange. So why did they launch this endeavor?
For the good of the market.
In Flash Boys, major buy-side institutions are under attack, with the very infrastructure designed to support them instead serving them up on a silver platter to a sea of financial piranhas. Whether or not this is true, it got me thinking about the original structure for exchanges and infrastructure.
For as long as public markets had existed, they’d been supported by exchanges and infrastructure that were created as a mutuals and funded by all participants for the good of facilitating transactions more efficiently. But in the late 1990s, our capitalist tendencies persuaded us that the mutual structure wasn’t pulling its weight in driving new products, technology, and price efficiencies. The diagnosis: an acute lack of profit incentive.
So one by one, major exchanges and infrastructure providers demutualized and became publically-traded, for-profit entities themselves, complete with the resulting corporate governance requirements and conflicts of interest. What we didn’t realize was that under this new, profit-seeking M.O., exchanges were designed and incentivized to seek out the largest revenue sources available -- and in recent years, that’s meant high frequency traders.
Suddenly, the new infrastructure and those that founded it no longer had aligned interests, encouraging the buy-side to seek out new options and opening the door for new “fair market” marketplaces like IEX. Whether success or failure, devil or savior, IEX exists because enough members of the buy-side community wanted it to.
This poses interesting questions about the past and future of our capital markets. Were we too hasty to overlook the consequences of rampant demutualization in favor of what we thought was a more profitable capitalist structure? Do we return to mutualized infrastructure or introduce another wave of new regulation?
Or, do we apply the traditional venture process to financial technology: a demand exists, a solution is created, a company is launched, and we all watch as a largely uncertain future plays out.
The reason we created VSL was because we believe that data, technology, and transparency are the answer -- and that this is the beginning of a wave of buy-side investment in technology and startups in recognition of the impact technology is having even in the most fundamental aspects of investment management.
Karl Antle is a Partner at ValueStream Labs. A highly adaptable technology enthusiast, Karl has global experience in Business Development, Corporate Finance, Strategy, and Operations specializing in technology enabled Financial Services businesses. Karl was a Principal in ... View Full Bio
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