Wolf Hunters from Wall Street. Part 4 (and the last)

Adaptation from the book of Michael Lewis "Fast Boys"

[ This is the last part of a series of translation adaptations of a recent Michael Lewis book. The first three parts can be read here: 1 , 2 , 3 - approx. trans.]

In May 2011Katsuyama's small team - Ronan Ryan, Rob Park, and a couple of other employees - were sitting at the office at the same table, surrounded by Technology Innovation Award-winning apps from The Wall Street Journal. The RBC marketing department informed them of the competition the day before the application deadline and offered to participate - so now they had to figure out which category to appear in and how to make the Thor program a favorite. “There were pieces of paper everywhere,” Park says. “Everyone said something unnatural, as if instead of us there gathered people who had recently recovered from a deadly disease.” “It was stupid,” Katsuyama says, “there wasn’t even a suitable category for us. I thought that in the end we will apply in the Other category. ”

The sense of the futility of this activity was in the air when Park said: "I got a crazy idea." His idea was to issue a technology license to one of the exchanges. The border between Wall Street brokers and exchanges at that time was blurred. For several years now, Wall Street brokers have run their own private exchanges. The stock exchanges, in turn, made attempts (inevitably fail) to become brokers. The largest exchanges offered services that allowed brokers to transfer their market orders to them, which brokers then redirected - first of all, of course to their own exchanges, and then to everyone else. The service was mainly used by small regional brokerage houses that did not have their own routers, but such a “brokerage” service, by its nature, opened up new opportunities, at least in the view of the Park. If only one exchange had a tool to protect investors from market predators, small brokers from all over the country would flock there, it could become the head of all other exchanges.

Forget it, Katsuyama said. “Let's just organize our own exchange.”

“We sat motionless for several minutes,” Park says, “staring at each other. Create your own exchange. What does that even mean? ”

A few weeks later, Katsuyama flew to Canada and tried to “sell” to his bosses the idea of ​​creating a stock exchange under the auspices of RBC. Then, in the fall of 2011, he discussed this idea with a couple of the three largest financial managers in the world (from Capital Group, T. Rowe Price, BlackRock, Wellington, Southeastern Asset Management) and several influential hedge funds (led by David Einhorn, Bill Akman By Daniel Loweb). All of them reacted equally. They liked the idea of ​​creating a stock exchange that would protect them from predators from Wall Street. They also believed that in order to assert with confidence that the new exchange is independent of Wall Street, a bank with Wall Street should not participate in its creation. Even as honest as RBC. If Katsuyama wanted to create a benchmark for other exchanges, he needed to quit his job and start his own business.

The difficulties were obvious. He needed money. He needed to convince a lot of high-paying people to quit their job on Wall Street in order to earn a small share of their current salaries - and perhaps even invest money in the enterprise. “I wondered: Will I be able to get the people I need? How much can we survive without earning? Will our influential environment allow us to complete the task? ” Allowed, and the Katsuyama team followed him in this venture.

But he also needed to figure out if the big Wall Street banks that controlled almost 70% of all investors' orders would want to send these orders to a truly secure exchange. It would be much more difficult to create an “honest” exchange if the banks that controlled the vast majority of client orders themselves were not interested in honesty.

Back in 2008when Brad Katsuyama realized that the stock market had turned into a black box, the internal activity of which eluded the understanding of an ordinary person, and began to look for gifted technology experts who could help him open this box and understand its contents. He started with Rob Park and Ronan Ryan, then others joined them. One was a 20-year-old Stanford junior student named Dan Aisen, whose resume Katsuyama found among a bunch of others on RBC. A line that caught his attention was: "Winner of the Microsoft University Puzzle Competition." Every year, Microsoft sponsored this one-day 10-hour national brain-marathon. He attracted more than a thousand young mathematicians and programmers. Eisen and his three friends took part in the competition in 2007 and won all the prizes. “It's a bit of a mixture of cryptography, ciphers and sudoku,” says Eisen. To be able to solve such puzzles, you need to have not only a mathematical mindset, but also an exceptional ability to recognize patterns. “This is partly mechanical work, and partly enlightenment,” says Eisen. Katsuyama gave Eisen both a job and a nickname, Lord of the Puzzles, soon shortened by RBC traders to the name Puz. Paz was one of those who helped create the Thor program. soon shortened by RBC traders to the name Paz. Paz was one of those who helped create the Thor program. soon shortened by RBC traders to the name Paz. Paz was one of those who helped create the Thor program.

The outstanding ability of Paz to solve jigsaw puzzles proved to be very helpful. The creation of a new exchange slightly resembles the creation of a casino: its author needs to be sure that customers cannot use it. Or, in the worst case, he needs to know exactly how to beat his system in order to be able to monitor its use - just like a casino follows those who count cards while playing blackjack. “You design the system,” Paz says, “and you don’t want to be able to beat it.” The complexity of the stock market - with all its private and public exchanges - was that you could just beat them - and beat them with ease - first smart guys from small firms, then “prop shops,” who crossed into large banks with Wall Street. That, Paz thought, was the problem. From the point of view of the most sophisticated traders, the stock market was not a mechanism for redirecting capital flows to productive enterprises - it was a puzzle that had to be solved. “Investing is not about winning against the system,” he says. “It's about something completely different.”

The easiest way to design a stock exchange that cannot be beaten is to hire the best of those who are able to do this and ask them to demonstrate their capabilities. Katsuyama did not know other champions of the country in solving puzzles, but Paz knew. The problem was that none of them had ever worked on the stock exchange. “The lords of the Puzzles needed a guide,” says Katsuyama.

And then Konstantin Sokolov stepped on the scene, who had once helped Nasdaq create his own matching algorithm - a computer that brought buyers and sellers together. Sokolov was Russian, he was born and raised in one of the cities on the Volga. He could explain why such a number of his compatriots came to high-frequency trading. The Soviet education system divided people into techies and humanitarians. And the state-controlled economy, terrifying and confusing, was riddled with various loopholes - such an environment allowed those who were able to subdue it to prepare well for Wall Street early XXI century orders. “Such a system has existed in our country for 70 years,” says Sokolov. "The more actively you cultivate a class of people who know how to get around the system, the more you get people who know how to do it perfectly."

Puzzles overlords might not have thought about this at first, but in trying to design their own exchange so that investors coming there did not become victims of predatory traders, they thereby foresaw the various ways in which high-frequency traders went to their victims. For example, these traders have helped public stock exchanges create all sorts of options for the ingenious "types of orders." For example, they created a type of order on the New York Stock Exchange that was executed only if the opposite order turned out to be smaller - the goal of creating this type of order was to protect high-frequency traders from buying a small number of shares from an investor who was ready to bring down the market by selling these shares at a meager price.

By exploring the types of orders, the Puzzles Overlords created a taxonomy of predatory behavior in the stock markets. Generally speaking, it seemed that there were three types of activities that lead to a huge number of cases of fantastically dishonest trading. The first they called electronic leading deals - traders saw that the investor was trying to do something in one place, and were ahead of it in another (this was what happened when Katsuyama traded in RBC). They called the second type “rebate arbitration” - it was carried out using legal “kickbacks,” or rebates, as they were called in the industry. Rebates were the result of complications aimed at capitalizing on any “bottlenecks” of the system: exchanges offered rebates, in reality not providing their liquidity, which, presumably, should have been their main trump card. The third type of activity, most likely the most common, they called arbitrage in the sluggish market. It arose when a high-frequency trader got the opportunity to learn about price changes on one exchange and “disrupted” trading on other exchanges before exchanges were able to respond to this. This happened around the clock, every day, and, in all likelihood, this type of activity generated much more profit over the year than all other types combined.

All three predatorystrategies depended on speed. And the very first, still immature idea to confront them came precisely with Katsuyama: everyone tried to get to the exchanges as close as possible - so why not try to distance the "predators" from the exchange as far as possible? Align yourself from the rest and not let anyone get close. The idea was to place exchange machines searching for correspondence between buy and sell orders at a considerable distance from the places from which traders connected to exchanges (these places are also called points of presence) and require everyone who wanted to trade on exchange, connect to it from a certain point of presence. If you place each market participant at a considerable distance from the exchange, then you can level almost everything, if not absolutely all the advantages, which can provide speed. The company has already decided that matching machines will be located in Wihoken (they were offered a good price for places in the data center). The only question was: where will the point of presence be located? Someone suggested: “Let it be in Nebraska,” but the company understood that it would be very difficult to force the already reluctantly cooperating banks with Wall Street to join their market if the banks also had to send their people to Omaha. Although, in fact, there was no need for anyone to go to Nebraska. The delay required for their new exchange as soon as a client’s buy order was executed on it, It was only to prevent high-frequency traders from entering the race for shares on other exchanges - that is, to prevent electronic leading transactions. The necessary delay, as it turned out, was supposed to be 320 microseconds; during such a time, they had, in the worst case, to transmit a signal to the most distant exchange from them - the New York Stock Exchange, which was located in Mahwah. Just in case, they rounded the delay time to 350 microseconds.

To create a 350-microsecond delay, they needed to place a new exchange about 38 miles from where brokers were allowed to access the exchange. And that was the problem. Having closed one good deal in Wihoken, they received a new offer: to establish a point of presence in Secaucus. The two data centers were located less than 10 miles from each other, and other stock exchanges and all high-frequency traders already rented space there (“We went straight to the lion's den,” says Ryan). A brilliant solution came to one of the new employees, James Cape, who recently joined the project, leaving the company involved in high-frequency trading: it was necessary to wind cables with fiber optic. Instead of using a straight cable running from one point to another, why not wind 38 miles of fiber into a shoe-sized coil and connect them to the main cable to simulate the effect of transmitting information over a distance? So they did.

Creating the conditions for fair play was surprisingly simple. They did not sell to any traders or investors the right to move their computers closer to the exchange and did not provide anyone with dedicated access to exchange information. They did not pay rebates to brokers or banks that sent orders; instead, they charged an equal fee on both sides of each transaction in the amount of nine hundredths of a cent per share (or nine mil) [ mil. from mille - "thousandth"- approx. transl.]. They provided only three types of orders: a market order, a limit order and a Mid-Point Peg order - placing such an order means that the investor’s order remained between the current purchase price and the sale price of any stock. If Procter & Gamble shares were quoted on a wide market at a price of 80–80.02 (you could buy shares for $ 80.02 and sell for $ 80), a Mid-Point Peg order would be traded at a price of $ 80.01. “It's kind of an opportunity to set an honest price,” Katsuyama says.

Finally, in order to be sure that their own motives remain in full accordance with the needs of investors, the new exchange forbade anyone who could trade directly from it to own part of the exchange: all its owners were ordinary investors, all their orders passing brokers.

But the major Wall Street banks, which controlled most of the investors' stock orders, played a much more confusing role in this picture than online brokers like TD Ameritrade. Banks from Wall Street controlled not only the orders and their information value, but also the dark pools on which these orders could be executed. Banks have used various approaches in order to maximize the benefits of their clients' orders. All of them sought to send orders primarily to their dark liquidity pools, and only then send them to a wide market. Inside the dark pool, the bank could trade against the same orders, or it could sell dedicated access to the dark pool to high-frequency traders. In any case, the value of user orders was monetized - by large banks from Wall Street to their own benefit.

If the Lords of the Puzzles were right, and the new exchange was indeed designed to level the advantage in speed, it could reduce the information value of market orders of investors to zero. If the orders could not be used on this new exchange, and the information they contained about the trading intentions of investors became useless, then who would pay for the right to execute them under such conditions? Large banks from Wall Street and online brokers that sent investors' market orders to the new exchange would thus be giving up billions in profits. And this, as everyone involved in the process understood, could not have happened without a struggle.

Their new exchange needed a name.They called it Investors Exchange (investor exchange) - the name was then shortened to the abbreviation IEX. Prior to the opening of the exchange, on October 25, 2013, 32 of its employees put forward assumptions about how much stock they would trade on the first day and the first week of operation. The average number was estimated to be 159,500 shares on the first day and 2.75 million shares in the first week. Only one employee who never participated in the creation of the stock market from scratch rated the exchange's capabilities the lowest: he suggested that trading volumes be 2,500 shares on the first day and 100,000 shares in the first week. Out of almost 100 banks and brokerage companies that were at various stages of drawing up an agreement on connecting to IEX (most of them were small enterprises), only 15 were ready to work together on the opening day of the exchange. Katsuyama suggested, or perhaps hoped, that the exchange would trade 40-50 million shares a day by the end of its first year of operation — such trading volumes were needed to cover the costs of the exchange. If this did not succeed, the question would arise about how long the exchange could survive. Katsuyama thought that their intention to create an example of an honest financial market - and perhaps change the culture of Wall Street - could take more than a year. And, as he said: "Everything will end when we don’t have any money left." Katsuyama thought that their intention to create an example of an honest financial market - and perhaps change the culture of Wall Street - could take more than a year. And, as he said: "Everything will end when we don’t have any money left." Katsuyama thought that their intention to create an example of an honest financial market - and perhaps change the culture of Wall Street - could take more than a year. And, as he said: "Everything will end when we don’t have any money left."

On the first day, trading volumes on the IEX amounted to 568,524 shares. Most of them came from regional brokers and brokers with Wall Street who did not have dark pools - RBC and Sanford C. Bernstein. In the first week of operation, trading volumes exceeded 12 million shares. Over the next week, these numbers grew slightly until, by the end of the third week of December, IEX began to trade 50 million shares a week. On Wednesday, December 18, 11,827,232 shares were sold and bought on the stock exchange. But the exchange still received relatively few orders from large banks. Goldman Sachs, for example, connected to the exchange, but orders from it came in batches of tiny sizes, were delayed on the exchange for several seconds, and then left it.

The first "uncharacteristic" for large banks, a Goldman market order came to the IEX on December 19, 2013 at 15 hours 9 minutes 42 seconds 662 milliseconds 361 microseconds 406 nanoseconds. Everyone who was in the IEX one-room office when this order arrived came to understand that something unusual was happening. Computer screens, as information spreads across the market, highlighted completely uncharacteristic images - noting that orders are held on the exchange long enough to start trading them. One by one, the employees got up from their seats. The noise of voices in the office grew.

“15 million!” Someone shouted at the 10th minute of a surge in market activity. In 331 minutes - since the opening of the exchange in the morning - no more than 14 million shares passed through it.

“Twenty million!”

“Thirty million!”

“We just got ahead of AMEX,” exclaimed John Schwall, CFO, referring to the American Stock Exchange. “We are ahead of AMEX in market share.”

“But we gave them a head start in 120 years,” Ryan said, somewhat loosely handling the story. Someone once gave him a 300-dollar bottle of champagne. He told Squall that it was worth $ 100 because Squall did not want any IEX staff to accept gifts worth more than strangers. Ryan fished out a smuggled bottle from under the table and found disposable glasses.

Someone hung up the phone and said: “They were from JP Morgan, asking what just happened. They say they may need to do something. ”

Someone else hung up. “They called from Goldman. They say that they didn’t even try to play big. They said that the big game will start tomorrow. ”

JP Morgan, in other words, could start redirecting their investors' trading to IEX, and Goldman were ready to send even more orders to the exchange than had already been done.

“Forty million!”

51 minutes after Goldman Sachs gave them the first honest chance to work with Wall Street customer orders, work in the US stock market stopped. Katsuyama left the trading room for his small office, separated from the room by glass partitions. He thought about what had just happened. “We needed someone to work with us and say,“ You're right, ”he said. “This means that Goldman Sachs agreed with us. Now others cannot ignore it. They cannot isolate us. ” Then he blinked and said: “Yes, I could cry now, damn it.”

He just had a picture of the future - he was sure of it. If Goldman Sachs is ready to let investors know that this new market was the best option for fair and stable trading, other banks will be forced to do the same. The more orders will go through IEX, the better the experience of investors from working with the exchange will be and the more difficult it will be for banks to avoid this new, more honest market.

IEX outlined its point of view: in order to function adequately, the financial market does not need to adapt to someone’s interests. He does not need payments for the joint placement and flow of orders and any other dishonest advantages that a small group of traders has. All he needs is for investors to take responsibility for understanding the market and then take control of it. “The essence of the market,” Katsuyama explains, “is in investors coming together to trade.”

Three weeks latertwo months after the opening of IEX, 14 people - executive directors or leading traders of a number of the world's largest financial companies - gathered in a meeting room on one of the last floors of a Manhattan skyscraper. Together, they controlled about $ 2.6 trillion in stock market investments, or about 20% of the entire US market. They flew here from all over the country to hear Katsuyama explain what he had learned about the US stock market since IEX opened for trading. “This is a great place to figure things out,” said Katsuyama. “This is not for you to watch what is happening, standing aside. We needed to be in the game to see it in all its glory. "

He realized how much the market wanted to stay in the shade. Despite the actions of Goldman, many large banks did not follow the instructions of investors, their own customers, who wanted to send orders for IEX. The few investors in the room knew about this; the rest saw the whole picture. One of them said: “When we told them that we wanted our orders sent to IEX, they replied:“ Why do you need this? We ourselves can do everything! ” After the first six weeks of IEX’s work, a large bank with Wall Street accidentally spoiled an important investor that did not send a single order to IEX - despite the latter’s explicit requirements to do so. Another manager of a large mutual fund estimated that when he advised banks to send orders to IEX, they followed the advice "at most in 10% of cases."

Other banks behaved mostly passively-aggressively, but there were cases of pronounced aggression. Katsuyama heard that Credit Suisse employees spread rumors that IEX was not an independent exchange - supposedly owned by RBC - and therefore IEX was just a tool for a large bank. He also heard that the big Wall Street banks are already asking investors not to force them to send orders to the IEX: the 350 microsecond delay that IEX used to upset the plans of market predators made this exchange too slow.

Shortly after the opening of trading, IEX published statistics showing, in general terms, what happened before on the market. Despite all the efforts of banks with Wall Street, the average trading volume of IEX certainly exceeded trading on any exchange, whether private or public. Trades on IEX, in addition, four times more often than on other exchanges, were carried out at a price average between the current market price of purchase and sale - this indicated that the price that the majority agreed was fair. Despite the reluctance of large Wall Street banks to send orders to IEX, the new exchange has already put up dark liquidity pools and public exchanges in an unattractive light - even based on their own far-fetched standards.

Katsuyama announced that he was ready to answer questions.

Someone asked: “Did you start thinking about [high-frequency traders] differently after the exchange was opened?”

“After we opened, I began to hate them much less,” Katsuyama answered. “This is not their fault. I think most of them just tried to rationally approach the fact that the market is inefficient, and tried to capitalize on this. True, what they did, considering all the legal restrictions, is amazing. They are not at all the villains that I imagined before. Investors were let down by the system. ”

“How many honest brokers work with you?” One investor asked.

“Ten,” said Katsuyama (IEX entered into agreements with 94 brokers). The top ten included RBC, Bernstein, and several even smaller companies, which, apparently, really worked in the interests of their investors. “Three of them are of great importance,” he added. "These are Morgan Stanley, JP Morgan and Goldman Sachs."

Another investor asked the question: “Why should a broker behave decently?”

“The long-term benefit is that when it comes [...] it quickly becomes clear who made good decisions and who made bad ones,” Katsuyama explained. In other words, when the stock market crashes - perhaps due to its excessive technological complexity, banks from Wall Street will begin to blame everything.

The stock markets really cheated. Katsuyama often wondered how enterprising politicians, plaintiff lawyers, and attorney generals would generally respond to this realization. (In March of this year, the New York Attorney General, Eric Schneiderman, announced a new investigation into the stock markets and dark liquidity pools in order to find out their relationship with high-frequency traders. Shortly afterwards, Goldman Sachs president, Gary Cohn ( Gary Cohn), published an article in The Wall Street Journal, claiming that Goldman Sachs could do nothing about the fraud on the market). Katsuyame was not particularly pleased with the idea of ​​persecuting those who led IEX to success. He just wanted to solve the problem. To a certain extent, he still did not understand

The clash of technology and Wall Street bore peculiar results. Technologies used to increase efficiency. But in addition, they were also used to introduce a kind of market inefficiency. Capitalizing on well-intentioned loopholes in the mid-2000s, Wall Street was largely committed to using technology to use information that people outside the stock markets did not own. The same system that once presented us with subprime mortgages secured by debt obligations, the work of which no investor understood until the end, has now come up with tenders for us on stock markets conducted for penny shares held at unsafe speeds and using order types, the meaning of which no investor understands to the end. That’s why Brad Katsuyama’s desire to explain things so that the rest of them also understand, looks so rebellious. He struck the newly minted mechanism of the financial system to the very heart, where money was made on his obscurity by the uninitiated.