In the world of Ronan Ryan, fortunes are made and lost in the blink of an eye and 350 microseconds is a game-changer.
The chief strategy officer of IEX Group Inc., who was featured in “Flash Boys,” the 2014 Michael Lewis book that sold 130,000 copies in its first week, shared his story recently at his alma mater, Fairfield University.
Before co-founding IEX, Ryan, who has nine years”™ experience in the financial services industry and more than 17 years”™ experience in networking infrastructure, was the head of electronic trading at RBC Capital Markets, a Canadian investment bank.
During his time there, his first title was high-frequency trading specialist. Working under his boss, Brad Katsuyama, Ryan and his team faced major frustrations when it came to electronic trading because each time a trade was executed, buyers couldn”™t obtain the full shares at the price they saw.
“Let”™s say I see 50,000 shares on the offer at a price, and I want to buy it at that price,” Ryan said. “Every time I press the button to go and buy it, I only get filled in on 50 percent of it. And the 50 percent I didn”™t buy is now a penny or two pennies more. But when I try to get the remaining 50 percent, that disappears as well and now it”™s up three pennies.”
Katsuyama, who was the head of electronic sales and trading at Royal Bank of Canada at the time, and Ryan soon discovered through Katsuyama”™s efforts that SAC Capital Advisors (now Point 72 Asset Management), Steven Cohen”™s hedge fund, had the same problem as RBC.
“SAC Capital would see 100,000 of shares at a price and buy it, but only get filled on 50,000 shares,” Ryan said. “And everyone there has just accepted that this is what happens. A trader said to me, ”˜You just can”™t get what you see.”™ And that”™s not OK.”
At RBC, Ryan and his team received a risk account of more than $100 million dollars to figure out why buyers couldn”™t execute on what they saw. Soon, the team realized the problem had to do with co-location, or the distance of a trading firm”™s software to the stock exchanges, which made a world of difference in actualizing transactions.
“If you”™re running a high-frequency strategy or just an electronic trading strategy in general, you need to interpret the data in a very fast fashion,” Ryan said. “The further away from the signal you are, the longer it takes you to get the signal. People in high-frequency trading would pay to put their strategies in the same data centers as the exchange for faster connectivity.”
When RBC developed a software program ”” named THOR ”” it disrupted the high-frequency trading market by introducing a way to stagger the arrival times of transactions to major stock exchanges”™ data centers in New Jersey.
“The first morning we hit the button, we were like giddy little school kids,” Ryan said. “We got every single thing on the screen that we saw. We had a frenzy on the floor.”
In the first month of using the new software program, RBC”™s loss ratio went down 35 percent, saving more than $5 million. Six months after rolling out the software to clients in June 2010, RBC had 454 new clients and $100 million of new revenue, Ryan said.
“Instead of saying high-frequency trading is bad, we used technology to fight technology,” Ryan said. “No one knew who we were until THOR came out.”
But Ryan wondered after reporting consecutive years of growth why some of RBC”™s Wall Street clients weren”™t trading through THOR. He said it was because  investors have other brokers and investment banks that provide services and the only way for investors to thank them is by continuing to trade with them.
After entering THOR into different competitions to showcase its technology, Ryan and his team began tossing around the idea of spinning it out of the company as its own product. In January 2012, Ryan and his team gathered 15 of RBC”™s largest clients in a room to propose the idea of launching THOR as its own technology company.
Ryan recalled a 2012 meeting, saying, “We said, ”˜What if the technology company became an exchange itself ”” an end destination?”™”
In October 2013, Katsuyama, Ryan and their team launched Manhattan-based IEX, the first equity trading venue owned exclusively by a consortium of buy-side (not in-house) investors, including a mutual fund, a hedge fund and family businesses. This mini exchange, also called a dark pool, just raised $75 million and has been cash flow positive for three months, Ryan said. IEX, plans to become a full-fledged stock exchange in July 2015 with SEC approval.
The strategy behind the exchange is to prevent predatory high-frequency traders from co-locating in the same building as its software program and finding out in advance what was just traded on the exchange venue because their connectivity signal is stronger.
“We wanted to install 350 microseconds of delay on the way in and 350 microseconds of delay on the way out,” Ryan said, calling it an “anti-co-location model.”
That 350 microseconds of delay is equivalent to one one-thousandth of a blink of an eye. Although that microscopic delay doesn”™t make a difference for buyers or sellers, it keeps high-frequency traders in line so that everyone finds out what trade happened at the same time.
The delay is accomplished via 38 miles of fiber that”™s coiled in what”™s called a “magic box.” Every trade that comes in through IEX goes into the box, spins around for 350 microseconds, comes out the other side and into IEX”™s matching engine where it matches the order, trades it and sends a message that spins around in another box and goes back to the front door.
Ryan said IEX hasn”™t become a relevant model for the U.S. equity market yet. But he has seen the tide slowly shift as senior leaders in major stock exchanges walk away from their jobs. He noted nine of the 44 employees at his company come from high-frequency trading firms, including people who held senior roles at Nasdaq.
In the one year of trading, IEX”™s record-high was 175 million shares in a single day. On its opening day, IEX traded 500,000 shares.
“We haven”™t proved anything or won anything,” Ryan said. “We have a lot of work to do.”
