IEX seeks to introduce “D-Limit” order, aiming to curb effects of latency arbitrage trading strategies

Investors Exchange LLC (IEX) has earlier this week filed with the Securities and Exchange Commission (SEC) a proposal to add a new Discretionary Limit order type (a “D-Limit” order).

The new order aims to protect liquidity providers from potential adverse selection by latency arbitrage trading strategies.

IEX proposes to amend IEX Rule 11.190(b)(7) to add a D-Limit order which may be a displayed or non-displayed limit order that upon entry and when posting to the Order Book, is priced to be equal to and ranked at the order’s limit price, but will be adjusted to a less-aggressive price during periods of quote instability. Otherwise, a D-Limit order will operate in the same manner as a displayed or non-displayed limit order.

The Exchange says that, by sending orders to “take liquidity” against orders that are resting on exchanges or other trading venues in very small windows of time, generally no more than a few milliseconds before an anticipated change in the NBBO (national best bid and offer), trading firms are seeking to exploit these speed and information asymmetry advantages. Thus, they can profit, to the corresponding disadvantage of institutional investors and other participants, whose resting orders are “picked off” by these faster firms at “stale” prices.

IEX further notes that this trading activity creates a substantial disincentive to market participants to provide exchange quotes and other orders that rest on exchanges’ order books. To compensate for the resulting adverse selection, among other reasons, many exchanges employ maker-taker style fee schedules which pay rebates to liquidity providers that trade on their markets.

This phenomenon, commonly referred to as “latency arbitrage,” has led to proposals by equity and futures markets specifically designed to provide protection for resting orders in order to encourage market makers and other liquidity providers to maintain tighter spreads with larger size.

IEX’s proposal to establish a D-Limit order type is designed to protect liquidity providers, institutional investors as well as market makers, from potential adverse selection by latency arbitrage trading strategies in a fair and nondiscriminatory manner.

IEX believes that D-Limit represents a logical extension of its efforts to date to create a trading platform stimulating participation by investors and market professionals and maximizes opportunities for investors to trade at a fair price. D-Limit orders would be available to all IEX Members in a fair and nondiscriminatory manner.