IEX Makes Money, But Lack of Rebates Could Slow Growth

  • IEX has been profitable for 13 months as a dark pool
  • Investors Exchange preparing to begin trading in August

IEX Group Inc. has been profitable for more than a year, using a business model that veers away from the revenue models of established stock exchanges.

The stars of Michael Lewis’s “Flash Boys,” who a month ago won regulatory approval to open the 13th U.S. stock exchange, run a private trading venue that has made money for the past 13 months, Chief Executive Officer Brad Katsuyama said in an interview. The next challenge will be snatching volume away from exchanges that pay rebates to spur business, something IEX refuses to do because its founders say it creates conflicts of interest.

“It’s going to be harder for us to grow market share” than other exchanges, Katsuyama said, speaking last week at Bloomberg’s New York office. “I see rebates as the biggest problem in markets.”

On June 20, days after IEX won approval to open the Investors Exchange, Katsuyama said the venue could become one of the nation’s largest stock markets. During last week’s interview he said IEX’s lack of rebates would mean its market share gains would come slowly. The company is still optimistic, he added, because regulators effectively limit the rebates trading venues can pay out to brokers, by capping how much they can charge to access quotes -- a limit Katsuyama said IEX won’t need to worry about as it grows.

For an explanation of what’s about to change at IEX, click here.

IEX currently operates one of the biggest dark pools, but will start transforming into an exchange in mid-August. Weeden & Co. analyst Andrew Upward recently estimated that IEX, which currently handles less than 2 percent of U.S. volume, could increase that market share once it’s operating as an official exchange to as much as 5 percent in the next five years. Based on current volumes, that would be good for sixth place.

Some of the markets run by the top three U.S. stock exchange operators -- NYSE Group, Nasdaq Inc. and Bats Global Markets Inc. -- pay rebates to traders who post standing orders that others can trade against. To offset the cost, they pick up revenue in other ways, including selling detailed data on what’s happening in their markets.

IEX doesn’t and argues fraction-of-a-cent rebates damage markets by skewing broker incentives as they determine where to send orders. The company charges traders 9 cents per 100 shares for most of the transactions -- orders executed in the dark -- on its platform. Based on the number of shares it handled, the company brought in just over $4 million of revenue in June, according to data compiled by Bloomberg. Gerald Lam, an IEX spokesman, declined to comment on the calculation.

SEC’s View

The U.S. Securities and Exchange Commission has questioned whether exchange rebates are a good idea, though it has continued to allow them. SEC Chair Mary Jo White flagged the practice in a 2014 speech, saying it may create conflicts of interest as brokers decide where to send orders. A committee advising the SEC this year recommended testing how markets would behave if they were further limited, which NYSE and Nasdaq opposed.

The rebate system has advantages, the SEC acknowledged in a memo last year. Banning the so-called “maker-taker” model could make it tougher for stock market players to determine fair prices of securities and drive more trading away from exchanges, according to the regulator’s analysis. Eliminating the fee model could also make quoted prices worse, negatively affecting retail investors, it said.

Exchange status comes with privileges that may open up new avenues for IEX to build its profits. IEX will earn a cut of the revenue the industry generates from market data. It can also list publicly traded stocks, collecting a fee from the companies it lists. Katsuyama said IEX would seek to steal already-listed corporations from other exchanges instead of luring initial public offerings.

NYSE, Nasdaq and Bats, the three giants of U.S. stock trading, have another feature in common: their owners are publicly traded. (NYSE is a division of Intercontinental Exchange Inc.) Katsuyama said that IEX has no specific plans to go public, or expand to new geographies, in the near term.

“We’re focusing on growth in the U.S. right now,” he said.

Before it's here, it's on the Bloomberg Terminal.