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June 18, 2008

Sweetening the Pot

Nasdaq Soups Up ETF Rebate to entice specialists

By James Ramage

The business of listing new exchange-traded funds is in the doldrums and so are Nasdaq's plans to build a competing ETF marketplace.

The exchange said last September that when it launched its new service in a month it would be shooting for 100 listings very soon thereafter. So far, it has added just nine to its initial 20. As part of its plan to lure infant ETFs, Nasdaq this spring sweetened the terms of its rebate policy for ETF market makers. Nasdaq recently began paying "designated liquidity providers," those market makers who seed and

support new ETFs, 40 cents per 100 shares for quoting the ETFs. Market makers get that rebate until the security's average daily volume reaches 10 million shares per day. After the security reaches that level, the rebate reverts to Nasdaq's standard tiered payout of between 20 and 25 cents.

Market makers, or specialists, are crucial to the launch of a new ETF because they "seed" the new security with their own funds.

Previously, Nasdaq paid the dealers 40 cents per 100 shares only until the ETF traded an average of 250,000 shares per day. After that, the rebate dropped to the standard pricing.

The latest move, which is being described as overdue, puts Nasdaq's ETF pricing on a par with that of the New York Stock Exchange's Arca platform.

Arca pays its lead market makers 40 cents per posted 100 shares.

The American Stock Exchange, the largest ETF-listing venue, has paid its specialist 24 cents per posted 100 shares since last July.

"It's been harder for Nasdaq to attract liquidity providers because of that ceiling," says Matt Hougan, editor of, which provides independent ETF and index funds analysis. "I did hear a lot of push-back from specialist firms."

For its part, the Amex is the largest ETF-listing venue, with 401 securities, according to Morningstar. NYSE Arca lists 248. Very few ETFs trade on the Amex, however. Most of the volume is done on Arca and Nasdaq.

By raising the ADV ceiling to 10 million shares, Nasdaq is essentially matching the policies of Arca and Amex, which impose no ceilings. The vast majority of the Amex's ETFs, for example, trade no more than 500,000 shares per day, according to data provided by Amex.

Nasdaq's Aims

Unlike its competitors in the ETF listings game, which have always employed a single specialist, or lead market maker, to seed a new ETF, Nasdaq is sticking with its multiple-market-maker platform.

When it launched its ETF marketplace last year, Nasdaq made it clear it would encourage more than one dealer to seed a single ETF.

Given the current slump in new listings-only 42 in the first four months of this year, compared with 259 last year-Nasdaq is convinced that a multi-dealer model is the future.

"That's why we raised the tiers: to have better economics to try to entice multiple people to designate seed capital," says John Jacobs, Nasdaq's executive vice president of financial products and marketing. "The number one issue I think [ETFs are] facing is seed capital. That's our mechanism to do that."

The days of the single specialist seeding capital for ETFs are over, Nasdaq's Jacobs adds. "We don't think that's the answer anymore," he says. "The economics have changed, and that's no longer going to happen."