A New Standard for Exchange Economics

IEX introduces a sensible fee structure for logical ports.

Our team at IEX published a white paper earlier this year titled, “The Cost of Exchange Services,” which gave detailed transparency on our costs to provide connectivity and market data to our Members. For IEX, it wasn’t a hard decision to be the first stock exchange to provide this type of disclosure — we did it because it’s consistent with what we stand for as an exchange.

We are grateful for the support the paper generated from our Members and the investors they represent, who appreciated IEX’s transparency on the potential profit margins that the legacy exchanges are earning on these products and services which have no competitive alternatives. IEX’s report confirmed the industry’s long held beliefs that the exchanges were abusing them with monopolistic pricing.

The most interesting topic which often came up in our follow-up conversations with Members was whether our policy for free connectivity and data was actually the most efficient and effective way to run our exchange. After some detailed analysis, IEX has identified one product — logical ports — which requires a sensible fee which IEX will begin charging on October 1st, 2019.

Before the cries of “IEX is now charging for something” begin, continue reading and you will see our rationale and the reason why we have made this decision.

Different Services, Different Economics

After disclosing our costs to provide market data and connectivity, we had some Members actually encourage us to at least cover our costs in providing these services. We conducted a detailed analysis to dig deeper and here were the high-level takeaways:

• We first considered proprietary market data and we saw no issues with providing this data for free. While IEX incurs an initial up-front cost in building our market data plant, there is very little, if any, incremental cost for IEX to add new users of this data. We want to encourage as many people to take in IEX market data as possible, which can lead to more trading, so “free” makes sense in this case.
• We next thought about physical connectivity and saw no obvious issues with providing free physical connectivity. There is very little cost to IEX and very little inefficiency in how our Members use physical connections to IEX.
• Lastly, we looked at logical ports, also called trading sessions, which are used by broker-dealers to submit orders to exchanges. This was the most interesting product to analyze because there was a large number of ports that we issued which have gone unused, and every incremental port requested creates additional cost for IEX.

So IEX has decided to charge for logical ports in excess of a base amount which we’ll continue to provide for free. But the question becomes: how much should we charge?

Free for All

IEX has offered free ports since launching as a securities exchange in Q3 2016. One consequence of not charging is that Members tend to request ports that aren’t used — which incurs no “penalty” since they are free! Also, the most port requests tend to come from a smaller subset of IEX clients (i.e., 10 of IEX’s 136 Members that use ports account for over 50% of our logical ports, with many of those ports going unused). In fact, over 25% of all logical ports that we provide to Members went completely unused in May 2019, and IEX incurs a cost to provide each port, even unused ports. As we disclosed in “The Cost of Exchange Services,” it costs IEX $1.5 million per year to support all of these ports, or about $83 per month per port.

A More Efficient Platform

Given the factors mentioned above, IEX is now proposing to charge $100 per month for each extra port after a user’s first five. This means that 75% of IEX users will continue to enjoy free ports (because they use five or fewer), which we believe is not discriminatory, does not create any barrier to competition, and provides a transparent, fair, and reasonable pricing structure which we outline in detail in our SEC rule filing.

We are also expecting that this incremental cost will help focus some Members on more efficient port usage (i.e., don’t ask for ports you won’t use), which will improve efficiency for our exchange.

We expect to recoup at most $960K of our $1.5 million in costs to support logical ports as a result of this new fee structure if no Members change their usage — however, we expect that Members will begin to optimize their port usage once the fee goes into effect.

Raising the Bar for Exchange Transparency

We were also focused on ensuring that our new fee filing aligns closely with the requirements of the Securities Exchange Act of 1934, to ensure that the analysis and justification we provide complies with Section 6(b) and Section 19(b), which require, among other things, that exchanges provide the information necessary to show that fees are fair and reasonable and do not impose a burden on competition.

For example, you will find these analyses in our filing:

• A line-item breakdown of our annual costs to support order entry ports (page 10)
• A breakdown of how the new fee structure would impact our Members’ monthly costs based on current port usage, and how much they could save after eliminating unused ports (page 14)
• A breakdown of how the new fee structure would impact our Members as bucketed by average order message traffic (page 17)
• A breakdown of how the new fee structure would impact our Members as bucketed by trading activity (i.e., liquidity-providing versus liquidity-“taking” activity) (page 18)

This level of detail and transparency is in direct contrast to the “cut and paste” general statements that are typical of other exchanges. Their filings often contain unsupported assumptions that the market for their products is “competitive” with no justification other than pointing at similar fees for another exchange’s product (which is not a viable substitute), or that the fee they are charging is justified because, “It costs money to run an exchange.”

We think our Members and investors deserve much more transparency and justification than has historically been provided, and we are proud to do so with this filing.>

Finally, IEX is voluntarily deferring implementation of the new fee until October 1. Although market data and connectivity fee filings are “immediately effective,” we think market participants should have a reasonable opportunity to assess potential fee changes, provide any feedback or written comments before, not after, the fee changes are implemented, as well as request to cancel any unused ports before the initial fee assessment (which we hope some Members do!).

We are hopeful that our rationale for this change makes sense and that the standard we are setting for exchange fee filings raises the bar for all exchanges going forward.

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