NYSE Backs Payments for ETF Market Makers
Traders Magazine Online News, May 4, 2012
Following a similar proposal by Nasdaq OMX, NYSE Euronext has unveiled a plan to allow market makers to get paid for providing liquidity for exchange-traded funds. If approved, the plan could reduce the number of funds listed without lead market makers.
On April 27, NYSE formally asked the Securities and Exchange Commission to authorize a pilot program that would add incentives for firms that become LMMs. Under the proposal, issuers would be allowed to pay an additional $10,000 to $40,000 per year to attract market makers.
Bryan Johanson, managing director for global index and exchange-traded products at NYSE Euronext, said firms have been increasingly reluctant about becoming LMMs, and the exchange wanted to offer an additional incentive to attract market makers to that role.
Bryan Johanson
Until 2007, all exchange-traded products listed on the NYSE Arca exchange had LMMs, which receive higher rebates from the exchange and pay lower fees in return for market-making obligations. In 2007, five of the 223 new funds that listed on Arca did not have LMMs. Last year, 297 new funds listed on Arca, and 26 of them did not have LMMs.
The lack of LMMs can cause serious problems for funds that are lightly traded. Even though an ETF is by its nature as liquid as its underlying securities—since shares can always be created or redeemed using the underlying stocks—a fund with a low volume and a wide posted spread will tend to be shunned by investors.
Under the NYSE plan, issuers could pay an optional quarterly incentive fee to the exchange, which would then use that money to distribute credits to LMMs that meet minimum performance standards.
Johanson said the exchange discussed the matter with market makers and found that around $10,000 to $40,000 was the level at which they started to consider taking on new exchange-traded products.
“We didn’t want this to be overly burdensome for the issuers,” Johanson said. “We tried to balance their interests with the market makers so we could come up with a figure that was appropriate and fair.”
A Financial Industry Regulatory Authority rule prohibits payments for market making, but NYSE argues this rule applies to securities of individual companies, not to exchange-traded products.
According to Johanson, ETFs probably weren’t even around when the first version of the rule was created. In spirit, the rule is aimed at preventing price manipulation, but that shouldn’t be a problem with ETFs, which are transparent and can easily be arbitraged against their underlying assets, he said.
Damon Walvoord, director of index and ETF sales and trading at Susquehanna International, which acts as an LMM, said he is supportive of the proposal, though he noted the modest incentives were not likely to lead to a sea change in the industry.
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