Recently, the Securities and Exchange Commission hosted the first in a series of roundtables addressing market structure issues.The Roundtable focused on the market structure for thinly-traded exchange-listed securities (both equities and exchange-traded products), specifically the challenges faced by market participants for thinly-traded securities and potential improvements that might be considered to the market structure for these securities.
A link to the SECs website on the roundtables follows.https://www.sec.gov/spotlight/equity-market-structure-roundtables.
The Roundtable consisted of three panels.The first two panels focused on the challenges in the market structure performance of, and potential improvements in the market structure for, thinly-traded securities, such as eliminating unlisted trading privileges (UTP) to concentrate liquidity in thinly traded stocks to their listing exchanges.The third panel focused on these issues but for exchange-traded products (ETPs).This summary will focus on the issues discussed relating to ETPs.
Panelists on the ETP panel were:
- Josh Kulkin,Head of Trading, Jane Street Capital
- David LaValle,U.S. Head of SPDR ETF Capital Markets, State Street Global Advisors
- Phil Mackintosh,Global Head of Economics andResearch, Nasdaq
- Laura Morrison,Senior Vice President andGlobal Head of ETPs, CboeBZX
- Greg Sutton,Managing Director, Citigroup Global Markets
- Charles Thomas,Head of U.S. ETF Capital Markets, Vanguard Group
- Kumar Venkataraman,Professor of Finance, Southern Methodist University
- Doug Yones,Head of Exchange Traded Products, NYSEArca
There was a persistent theme throughout the Roundtable, i.e., that there should not be a one size fits all approach to market structure; this was no different as it related to the discussion of ETPs, according to ARi Burstein at Capital Markets Strategies. Several of the panelists emphasized that ETPs are different from single stocks, both in how they are constructed and how they trade, and that the SEC needs to take this into account when examining any changes to the current market structure.
Brett Redfearn, Director of the SECs Division of Trading and Markets, asked several questions of panelists during the discussion, playing off of the panelists opening remarks.The most significant issues discussed in response to those questions follow.
Measuring Liquidity for ETPs
A number of panelists noted that, as opposed to single stocks, ETPs can be thinly-traded but, at the same time, also highly liquid.Care therefore needs to be taken in the terminology used relating to ETPs, as well as the measurement of liquidity of ETPs.Significantly, panelists emphasized that ETPs are different from single stocks in that you need to look at the underlying basket to understand their liquidity.
Several of the sellside panelists discussed how they examine the impact of trading in an ETP, and said that they look to the impact of having to trade in the underlying securities in the basket, i.e., deconstruct the ETP and examine the underlying.Brett Redfearn asked the sellside panelists whether there are some ETPs that are just too illiquid to touch.Two of the market makers stated that they would make markets in any ETP, but that the spread may just be wider in some.
The ETP issuers on the panel reiterated that there are two layers of liquidity when it comes to ETPs – the ETPs liquidity and the liquidity profile of the underlying basket – and that it would be tough to find an ETP that you can truly call illiquid.All agreed that one of the takeaways from the Roundtable is that the SEC needs to reexamine ETF liquidity measurement.
Market Maker Incentives and FINRA Rule 5250
There was a somewhat lengthy discussion around payments to market makers, FINRA Rule 5250, and any benefits that changing regulation in this area may bring to ETPs.
One of the ETP issuers asked what problems we are trying to solve by changing the current rules in this area.He noted that there may be too many ETP products in the marketplace and that sometimes for market makers, the costs will just outweigh the benefits of being active in a particular ETP.He also noted that any payments a fund may make to a market maker would come at the expense of higher management fees and that going to a pay for market maker regime may result in funds using less market makers than today, potentially having collateral impacts on market makers’ involvement in an ETP (e.g., those that are not paid will likely not get involved with that particular ETP product).Another ETP issuer on the panel agreed that paying market makers directly would be a cost incurred by long-term shareholders of a fund and therefore possibly a subsidization of short-term traders in that fund.They also noted that there may be complications in implementing such a system, e.g., accessibility to data to see how market makers are performing using direct payments.
One of the exchange representatives on the panel noted that some ETP issuers have stated that they would enjoy the opportunity to pay market makers directly and that, with proper oversight, this could be an additional tool for ETP issuers.They admitted that this may not be of value to every issuer or every product but it can be an additional tool.
Other Issues Discussed
Minimum Creation/Redemption Unit Sizes:A number of panelists, particularly the sellside participants, discussed allowing ETP issuers to have flexibility as it relates to the size of creation and redemption units.A market maker on the panel emphasized that this would allow them to better facilitate the trading of smaller ETPs that do not trade a lot.
Impact of Eliminating UTP:Brett Redfearn asked if the SEC were to take action in the area of UTP, would panelists want ETPs to be outside of any pilot program, for example, that the SEC might construct.There did not seem to be overwhelming support for the elimination of UTP in the context of exchange-traded products.One panelist stated that being derivative priced instruments, if a pilot resulted in a change in the liquidity quality of the underlying securities, that will impact ETPs and that we should be careful of such an impact.
