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Some Like It Hedged

BNP Asset Management's Pojarliev discusses a variety of options to address foreign currency exposures. Although there is no single best-practice solution for addressing foreign currency exposures, institutional investors have three main choices, he says.

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November 1, 2010

Cover Story: In Search of Market Makers

By Peter Chapman and James Ramage

All of the hubbub begs a number of questions. Is it really necessary for the public markets to be supported by dedicated market makers? Should registered market makers be required to quote at the NBBO and provide minimum size and depth? If so, should they be given benefits unavailable to other market participants? And what of the exchanges themselves? Do they really want to impose obligations on HFTs and market makers? Would they want to bear the inevitable costs associated with greater market maker support? Isn't the existing "flat" model in use by most exchanges good enough? What about the HFTs? They are currently providing up to half the liquidity in the market. Should they be asked to do more? What about the registered market makers? Their main business is to make markets for their customers, not the public markets. Should they be asked to do more for the exchanges? And, finally, what exactly is a "market maker?"

In some jurisdictions, including those in Europe, any firm that exceeds a certain level of activity is required to register as a market maker and assume quoting obligations. That's regardless of whether or not the firm is doing a customer business. In the U.S., by contrast, SEC rules only rope in firms trading on behalf of customers. So, while firms such as Merrill Lynch are required to register as "dealers" with the SEC, for doing a market making business, proprietary trading houses such as Renaissance Technologies are not.

Under SEC rules, there are two types of market makers: exchange market makers and over-the-counter market makers. Rule 600 of Regulation NMS defines an exchange market maker as "any member of a national securities exchange that is registered as a specialist or market maker pursuant to the rules of such exchange."

In other words, the SEC has punted regulation of market makers to the exchanges. While that may have made sense when the NYSE was the primary stock exchange in the U.S., it may not in a world where liquidity is fragmented over a dozen exchanges. Only one exchange--the NYSE--has a robust market maker program with affirmative, if not negative, obligations.


Federal Rule

Some would like to change this scenario. Chris Concannon, a partner at Virtu, and formerly a senior Nasdaq official, wants to see the SEC adopt universal rules governing market maker behavior. Concannon is not advocating the registration of HFTs as market makers, but does want to see the SEC pass a beefed-up rule covering existing market makers no matter where they trade.