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IEX's Threat to NYSE No April Fool's Joke

NEW YORK (TheStreet) -- Michael Lewis' new book, Flash Boys, claims to be about a plot against small investors, but is itself a plot against the New York Stock Exchange.

As an excerpt at The New York Times shows, buy-side traders who feel victimized by high-frequency trading are backing an alternative exchange called IEX that promises to cut the high-frequency guys out of the order flow and, as a result, give small investors better pricing.

IEX is a threat to NYSE's parent company, Intercontinentalexchange Group (ICE - Get Report), and savvy traders have figured that out. Shares of ICE are trading slightly below the level they were at when the deal was concluded. They closed Monday at $197.83, compared with $198.70 on Nov. 13, the day the NYSE-Euronext deal closed.

IEX is a threat to ICE because, despite what you may see on your TV screens each morning, the NYSE doesn't consist of people so much as it does of computers. And computers can be replaced by other computers.

A lot of the NYSE's trading volume doesn't take place at the stock exchange at all. There are 44 active alternative trading systems such as IEX, and many broker-dealers handle trades internally without going to an exchange. Alternative trading systems are non-exchange trading venues that match buyers and sellers.

ICE runs fully computerized markets for commodities and currencies futures, and it went after NYSE-Euronext mainly for the exchange's global derivatives market, Liffe. ICE's success is tied closely to global trading desks at the same firms that created high-frequency trading.

IEX -- which operates as a dark pool (it doesn't disclose the identity of the traders or the bid and ask prices) but which plans to display prices later this year -- is backed by a group of mutual funds and hedge funds. It has lured Jim Clark -- co-founder of Silicon Graphics in the 1980s and Netscape in the 1990s -- to its board for star power and Silicon Valley street cred.

IEX revealed its trading rules in October, daring competitors to do the same. The rules include a 350-microsecond delay between trade requests and executions, a delay aimed at reducing the advantages of high-frequency-trading systems.

Before ICE' acquisition was completed, NYSE Euronext and Nasdaq OMX Group (NDAQ - Get Report), which runs the Nasdaq market, asked the Securities and Exchange Commission to consider a trade-at rule, keeping trades out of private venues unless they offered better prices than the public market.

The Financial Industry Regulatory Authority began considering such a rule in September with amendments to the filed in January.

The rubber will really hit the road when IEX starts displaying its prices. If buy-side brokers find that they can get better prices for their orders by routing them away from the NYSE, then many will do so and the NYSE floor could become a true false front, with nothing behind it.

At the time of publication, the author owned no shares in companies mentioned in this article.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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