Here’s how NASDAQ’s proposed Market Quality Program will work:
In addition to the annual listing fee, the issuer of an eligible security can opt in and will pay $50,000 a year into the program for a security, to be split equally between quote and trade payments to market makers.The issuer can add another $50,000 per product to the program split at will between the quoting and trading incentives.
Market makers register voluntarily in the program on a security basis and are paid on a pro-rata basis for:
a) Tightening spreads and offering liquidity. To be eligible for payment, they must quote in 500 shares at the NBBO for at least 25% of the time and bid/offer 2500 shares no wider than 2% outside the NBBO for 90% of the time;
b) Trading; payment is pro-rata’ed across those in the program.
The payment is also "use-it-or-lose-it", so if nobody trades in a month or meets the quoting criteria, the money reverts back to the issuer. As the program is voluntary, this also means market makers not in the program and other market participants can trade alongside; if outside the program, they will not be eligible for payment, while those in the program will miss out if not competitive. The payment structure allows market makers to choose which securities to be particularly active in during any one month. And when trading in an ETF meets an ambitious 2 million shares a day, the paid program ends.
All exchanges have on their books a rule that aligns with a FINRA Rule 5250 and bars issuers from incentivizing market markers directly for the obvious reason of market abuse and false price floors being established. Arguably ETFs are hard to manipulate due to their derivative nature, and frankly an attempt to rig the price of a relatively illiquid derivative security in a highly monitored program with a strong electronic footprint verges on stupidity.
Success will largely be defined by the issuers’ willingness to support the program and the market makers’ ability to turn a profit. Two hundred dollars per security per day adds up to a tidy sum across a lot of symbols but it remains to be seen if this is enough. A successful program will also sort the ETF wood from the trees: if one security in the program is successful and another not, it begs a question as to whether products should be withdrawn; likewise ETFs left to languish outside the program will stick out like sore thumbs in the statistics.
The rule filing is waiting to be ‘noticed’ by the SEC, which will start turning the wheels of the rule filing and formal commentary process. If ultimately approved, the writing is on the wall for equities.There is little on the regulatory table at the moment to improve market quality,but prior success of a similar program abroad and political concern over how to improve the lot of smaller securities at least gives this proposal a decent chance of making it to the pilot.
Let the comments begin.
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7 Comments to "Breaking Taboo: Issuers Paying Market Makers ":
Anonymous
10 April 2012
The filing has been noticed by the SEC
bernie_thurston
12 April 2012
This is one of those ideas that seem to be a good idea in theory, but in practice all it will do is highlight the ETFs that do not fall into the arbitrary bucket of high enough liquidity. This will split ETFs in the same manner that has has occurred in Europe with physical and synthetic, with the same perceived good/ bad ETF distinction. This will provide an advantage to the big ETF providers, producing products on standard indices, and shut out small providers on niche products. ..
Comments (3)
mmizen
13 April 2012
Thank you for your comment Bernie. Is there an optimal alternative or are you suggesting leave well alone?
It has been interesting to note the mention this proposal is having in the press, but there appears a lack of comment about issuers and market makers. We shall see when the commentary period opens.
Comments (41)
bernie_thurston
16 April 2012
There have allegedly been endorsements of this from Adam Patti, CEO of IndexIQ, Greg Friedman, head of ETF product development at Russell Investments, and Reggie Browne, managing director at Knight Capital, but at the end of the day I would advocate leaving alone. The spread and liquidity is one measure of the health of an ETF. Distorting this measure seems to be detrimental to the industry as a whole.
Comments (3)
sarnuk
17 April 2012
Bernie, one element of your argument is intriguing to me:
"The spread and liquidity is one measure of the health of an ETF. Distorting this measure seems to be detrimental to the industry as a whole."
Often times I think the same way with regard to the incentivizing of any liquidity. Should markets for any instrument, including stocks, be reflective of only activity related to supply and demand, un-incentivized, for true price discovery to rule?
Comments (160)
bernie_thurston
18 April 2012
Sal, I agree; indeed for true price discovery the market should be reflective of the pure interaction. Inducements of any type distort the market and all we will achieve is to alter one market for the formation of another whose aims may be divergent.
Comments (3)
sarnuk
18 April 2012
Miranda, my partner Joe wrote this blog post on April 13th: http://blog.themistrading.com/payment-for-order-flow-is-alive-and-well-on-wall-st/
Payment for order flow is distortive, period. Even Professor Angel, someone we disagree with from time to time, in his Equity Trading in the Twenty First Century, opined that the maker/taker model employed by all the exchanges distorts the price-discovery process.
I hope you don't mind adding Joe's link from 5 days back to this forum.
Comments (160)