U.S. Equity Investors Question Value of Electronic Market Makers

Liquidity from electronic market makers has become an integral part of the U.S. equity market, but the firms that deliver it remain largely unknown to many institutional investors whose trades often involve these little-understood firms. This opacity has created a level of fear among investors about the quality and reliability of electronic market makers.

Market making in U.S. equity markets has changed significantly in the last two decades. The system, once ruled by large banks and brokers making markets on the NYSE floor or on Nasdaqs electronic order book, is now dominated by smaller, less well-known electronic market makers. A new report, U.S. Equity Market Makers: Fear of the Unknown, from Greenwich Associates concludes that institutional investors are unfamiliar with who these electronic market makers are and how they operate, and are skeptical about the quality of the liquidity these firms provide. In fact, almost 15% of the 78 institutional equity traders participating in a recent Greenwich Associates study did not know whether or not they were trading with electronic market makers.

Buy-side traders think the risks associated with electronic market makers might actually be greater than the benefits they create, says Richard Johnson, Vice President of Market Structure and Technology at Greenwich Associates and author of the new report. However, the report also finds that 82% of study participants would be open to routing more flow to market makers under certain scenarios – for example, if it would result in better liquidity and larger execution sizes.

Its clear that all parties could benefit from better understanding between electronic market makers and the buy-side community, especially as regulators and the industry move forward with important alterations to market structure, says Richard Johnson.

To facilitate that better understanding, the new Greenwich Associates report identifies and examines investor perceptions of some of the most important market makers. It examines the role of electronic market makers in channels including exchanges, dark pools and internalization engines, and assesses investor opinion about the quality of liquidity these firms create.