TYLER NEVILLE: I'm Tyler Neville with Real Vision and we're at IEX Offices in the World Trade Center. I'm going to be sitting down with Ronan Ryan, the President of IEX and we're going to be talking about market structure liquidity and the incentives of exchanges.

Ronan Ryan, here we are. President of IEX, but also well known for a character in Flash Boys, in Michael Lewis' book. Thanks for having us in your office.

RONAN RYAN: Character of myself.

TYLER NEVILLE: Yes. A character. Yeah. Huge character. So, wanted to dig into your background. Why don't you tell us how you got to IEX and how you met Brad and take us back.

RONAN RYAN: Yeah, it's a funny story. But I actually met Brad and worked for Brad at RBC before we formed IEX. I had worked in the telecom sector for years, had originally wanted to work on Wall Street. It's in the book, but I could not get a job on Wall Street. So, I took a job and learned technology on the telecom side. And then it was around 2004, trading and technology started banging into each other. And by that, people started to care how fast they traded.

And I happen to be in the right place at the right time, you make your luck, but you got to be lucky, I was at a company called Radiance. And I got a call one day from a black-box trader and not knowing what the hell a black-box trader was, and had said, look, you know infrastructure, if I move my strategy from Kansas to New Jersey, can you collocate me, meaning put me in a data center near the exchanges? And I'm like, of course, we can do that.

And it was funny story and that he was complaining over the phone how it takes him 43 milliseconds to send a trade from Kansas and to receive acknowledgement of the trade. And I had no idea what a millisecond was. But I told the guy I'm like, yeah, that sounds terrible. And when we moved them, we lowered it to 3.9 milliseconds, which sounds Fisher Price slow now, like 15 years later, but at the time, this guy was thrilled, he was so happy with the move. And anyway, he was introduced to me by a prime broker at a Bulge Bracket. And I went back to the prime broker at the Bulge Bracket and said, do you have any more of these black-box traders and I guess black-box traders became high frequency traders.

And I started building out a lot of environments for all these guys to move to New Jersey, connect to the exchanges, then the exchanges themselves got into the business of selling space and selling technology and even selling circuits to connect their own clients to their competitors, which is bananas. But that's where it morphed to. And I wanted to move to the business side and was meeting with a lot of brokers. And then one day, a broker called me and said, would you talk to the Royal Bank of Canada and went in there and met with about 17 people, which is how brokers interview apparently, and just started working a few weeks later, and we were working on the trading floor.

I was working with Brad, when we came up with a Tor smart auto-router, was like famous for arriving at all venues near simultaneous to get the best fill rate that took off. RBC did remarkably well. But then a lot of clients said to us, we can only use your technology when we trade with RBC, if you think of something bigger, we'll support you. And that really was it. So, we looked at it and said, well, the center of the ecosystem are the stock exchanges. So, why don't we launch a stock exchange? He says not that sounds none of us have ever even worked at a stock exchange. And we set out to build one and there was Brad, myself, John Schwall, our COO, and Rob Park, our CTO were the four first people who came up with this idea.

TYLER NEVILLE: One thing I want to talk about in this interview is market structure, which is an overarching, if you want to go David Foster Wallace, it's the water that's around us in investing that no one really pays attention to. And I think it's such an important piece of the investment component that most portfolio managers don't understand market structure and liquidity, and it's a huge gap in knowledge. So, can you take us back in time to like the '90s and start maybe there when regulation started coming in? And the market got fragmented and gave us a history there?

RONAN RYAN: Yeah, happy to. And before I do that, I will say this, it was remarkable to me when the book first came out on Flash Boys in 2014, the buy side traders had become well enough versed in market structure. But because the book shine a light on equity market structure, a lot of the portfolio managers asked us to come in and present to them. And it was only then that I think they realized that the work of the trader itself, the buy side trader was far more detective work than they had imagined. I think people had thought with the electronic application of everything and you just plunk it in algo, set it and forget it and everything's fine.

And I think it was then that those PMs that showed an interest in that really respected how many venues exists and how their traders source liquidity. So, I guess it would go back to like the '90s. The first thing was like reg ATS. ATS was alternative trading system. It just allowed more competition. So, you have, today, you have stock exchanges, and you have ATSes. Another word for ATSes that most people know them as are called dark pools. But an ATS is basically a baby exchange. It's a less regulated exchange.

And really, up until the '90s, you had the NASDAQ and the New York Stock Exchange, and you had the regional stock exchanges, but they had very little volume and then late '90s, you started with the advent of Archipelago and INET and those were 100% electronic exchanges, no humans involved- as well as NASDAQ in fairness, which was already a few decades old, but the electronification and the fragmentation of the market let itself the competition and then in the early 2000s, there was decimalization where you could trade in penny white increments.

And then also, you did see a lot of his exchanges started to buy- the incumbent exchanges started to buy the smaller guys. Why? Because they had better technology. So, NASDAQ now runs on old Island INET technology, New York Stock Exchange bought Archipelago, didn't really adapt to the new technology. I think they'd been rolling out their new pillar platform for the last few years. But in essence, they bought those platforms because they didn't want to compete with them anymore. And they wanted to avail of their technology.

But with all of that, I think there was a great book, called Dark Pools that was written by Scott Patterson, and it's all about market structure and the chronology- I'm not sure if you've read it. And if you haven't read it, you should read it. Because it do a much better job of answering this question. But it has the entire chronology of the creation of INET and ARCA and just even the messaging like everything now is all trading is done in like fixed protocol, just the invention of fixed protocol, the dissemination of market data. But it lends itself to collocation, meaning collocation came about in the early 2000s, where the biggest proponent of latency of delay, a fancy way they say, propagation delay. It just means the further away from the signal you are, the longer it takes you to get the signal.

You're in California versus New Jersey, or New York versus New Jersey, which is funny, because you have tons of exchanges like Chicago, Boston, New York, Philadelphia, IEX, all 13 exchanges are in New Jersey, and all of them are in four buildings in New Jersey. And that's more often because people want to be in the same building as the exchange. So, from back when I was telling you before, 3.9 milliseconds mattered back in 2004-2005. Now, if you collocate, meaning, you put your strategy in the same building as the exchange, so you're as close as possible to the exchange, that latency is measured in nanoseconds, which are billionth of a second, which is again, comedic because when people first moved to the building, they wanted a cable to connect to the matching engine of the exchange.

Now, it's gotten to the point where people are complaining that client A's cable is shorter than me, so they can get to the matching engine quicker than me which again, it's 11.9 inches, I think, technically, but roughly, a foot of cable equates to one nanosecond. So, what New York Stock Exchange got a lot of credit for is they measured the furthest cabinet away from their matching engine, and gave everybody the same length of cable, which people found interesting but the one a lot of people haven't heard of, I thought, was really interesting is then the people closest to the matching engine started to ask the New York Stock Exchange to move them further away because a straighter cable had less light refraction and was must have been trillions of a second faster.

TYLER NEVILLE: So, it's gotten that ridiculous.

RONAN RYAN: Yeah. So, it's gotten that ridiculous, and it continues to get more and more so. So, every little increment of speed, like if you run a strategy that's sole determinant of success is based on speed, if you fire in response to a signal at the exact same time as someone else, and you get into the matching engine, a billionth of a second before them, well, then they're second, you're first, or vice versa, you come in second and they're first, that equals success. So, many strategies, not all strategies, but many are predicated on being the fastest of the fastest.

So, there's an entire industry, an industry in which I guess I grew up in was then making every facet of the trading cycle faster and faster and faster. And the ironic thing is, I've never traded a day in my life. I've never traded a day in my life. But I spend a lot of time talking with traders, telling them how they should navigate a market. I'm not suggesting we tell them how to trade.

TYLER NEVILLE: But the funniest part is you're probably the most qualified trader on the Street by knowing all the technology.

RONAN RYAN: Just use a watered down Irish accent and a few f bombs. Actually, from him.

TYLER NEVILLE: We checked and drop them.

RONAN RYAN: I'm allowed on camera.

TYLER NEVILLE: Yeah. But so, the decimalization happens, spreads completely tightening. But what's fascinating is, liquidity has gone down since 2007, which is really bizarre to me. Do you have any perspective on why that is?

RONAN RYAN: Yeah. The average daily volume is down around what like 7.1 billion shares a day now. And I think it spiked close to 14 billion in 2009. Numbers might be slightly off. But in and around that realm. I think what you'll find is, and we've often said this, there's a lot of unnecessary liquidity, even in the current market, meaning there's buyers and sellers in the market at the same time. The problem with the market is there's 13 stock exchanges, 30 plus dark pools, and the buyer and seller are in at the same time, marketable against one another, but they're just not in the same venue.

And then what happens is someone will buy from the seller in one venue, maybe 100 shares at a time, and go and try and find a buyer in another venue. But what that does is it's like the triple threat. You've 10,000 shares enter one venue, 10,000 enter another. Optimally, you'd like to see the 10,000 shares trade with one another. But if someone buys from this seller, sells to this buyer, and they just go 100 shares at a time and they eventually satisfy that trade, while the tape sees 20,000 shares.

So, when a portfolio manager is giving an order to their traders saying, hey, maintain 10% of volumes, so 2000 shares because there's 20,000 shares. Well, really, the real volume in the market in that instance, was 10,000. There was a natural 10,000 buyer and 10,000 seller. So, there's a ton of just bullshit liquidity out there. And it doesn't matter what broker you use, what algorithm they use, there's no algorithm that could possibly have gotten you that 20,000 because there just wasn't 20,000 of interest to begin with.

But more importantly, it causes people to maintain a percent of volume just as an example, instead of 1000 shares, 10% of 10,000. Now, you're buying 2000 shares, 2000 shares might force you to cross the spread out in New Jersey, send an order out, spread out there, crossing the spread causes the quote to change. When the quote change, the person who knows the quotes change first has an advantage over everybody else. It was cyclical. So long that that answer to your question, in that instance, a huge percentage of that liquidity is just unnecessary doubled liquidity.

TYLER NEVILLE: Yeah. So, my perspective- and I was at a giant $800 billion asset manager before, and we had these different mandates for stocks where you had to maintain a certain percentage say it was 20% of the time. So, being 20% of a daily volume, just a couple of years ago, you were really mimicking maybe 40% or higher of that traded volume like you're saying. And that might even lead to underperformance on your overall funds, when you're trying to move an aircraft carrier in a tiny little river, it's almost impossible to do.

RONAN RYAN: It's impossible to have no impact. Just two weeks ago, I was with a large buy side institution that has- it's consolidating a bunch of others as more people acquire one another, and they're getting bigger and bigger. And their head trader was telling me it's a pain in the ass, as people will say, well, if you don't want to have impact, just lower down your percent of volume to like 3%. But if you're trying to get a position on and you're doing 3%, 3%, depending on the size of the position could take you months to execute. So, that doesn't make sense, either.

So, how do you execute without impacting the market? Well, if there was real liquidity, and not just this, I don't want to say that all liquidity is Phantom liquidity. But if there's PS liquidity that's not real wasn't in the market, I honestly think you could take 30% of the ATV out of the market, lower it 7 billion by 30%. And if it's just real liquidity, it'd be easier to trade.

TYLER NEVILLE: Yeah. Can we switch directions and basically go to the exchanges? And talk about how they are the main- they're one of three owners of the entire ecosystem. And what their incentives are.

RONAN RYAN: Yeah. We've publicly gone after their incentives recently. And I will say, we've had this view forever. So, this is not like a changing thing at IEX from day one. Notably, what I'm talking about first is like market data and charging for technology. So, from day one, from our days as a dark pool, ATS, we've never charged for any connectivity to IEX, we don't believe in that. We don't believe in paying rebates for order flow.

The current exchanges, and what's been great about this recently, as we put out a white paper on IEX's costs to provide market data, the entire brokerage community was very happy. Because if you talk to brokers, and you ask them over the years, their technology fees have gone like this, like astronomical, 700%. Our fees that we pay the exchanges since 2013 have gone up already 400%. So, you have these brokers constantly- you're a broker, you're paid on a variable basis, meaning you're paid on a per share basis. But at the beginning of the month, you have to write a check to all these exchanges for a cross connect spin port, flux capacitor, collocation, all these things in this environment, which a lot of people know who are watching this, in this reg NMS environment, the brokers are required to connect to all these exchanges.

So, you have three families, like you said, but the three families own 12 separate venues, and you have to pay to connect to each of these venues. And each of these venues have their market data. So, that's why you don't see consolidation like you do in most industries. If someone buys three other competitors, maybe they would consolidate them, you don't see that in the exchange landscape. So, I think when with technology fees going like this, and the average daily volume like we discussed earlier going down, it's harder for brokers to make money. And there's been some buy side pressure to lower the commission rate.

And all in all, you lower the commission rate to such a level, the fees are a level, average daily volumes down. And then people are just like stunned that a broker might try and get a rebate from an exchange instead of paying a take fee. And I think the greatest example is if you look at NASDAQ, tier one, tape A names, it cost you 30 mils to take liquidity on that venue and the rebates, 29 and a half mils. So, it's a 59 and a half mil swing when you make our take on that particular venue. When the average low touch execution buy side probably play the sell side, somewhere between 50 mils and 75 mils.

So, my thing and I've said this to the buy side, this is not an attack on the buy side at all. I'm saying if post the transaction fee pilot, which is basically testing the band of rebates, or lowering the take fee, the most an exchange can charge to take is 30 mils, they're lowering it in one of their buckets down to 10 mils. If the determinant at the end of this pilot is that the exchanges can't charge 30 mils to take any more, the max they can charge is 10, the buy side should consider not just automatically lowering your commission rate by 20 mils. And I think let the dust settle and see how brokers can make more money in an environment like that.

And that's been something, obviously, as I say it, I can see why the brokers are supportive of that message. But in fairness to them, because we are in effect, we have a broker dealer for our router here. And we have to connect to these exchanges. And like I said, on any given month, they can charge us whatever the heck they want for anything.

TYLER NEVILLE: So, recap high level. They're really generating, as trading volume goes down the