The New York Stock Exchange Arca platform has renewed steps to implement its own version of a market-maker incentive program that would allow issuers to pay market makers to keep spreads tight on certain exchange-traded products and the funds liquid. The latest proposal looks quite similar, if not identical to a plan the NYSE nixed early this year.
In the latest paperwork it filed with U.S. regulators, the exchange proposed adding “NYSE Arca Equities Rule 8.800” to the book, the same name detailed in its earlier petition with the Securities and Exchange Commission. It wasn’t clear why the first plan got shelved, and officials at the NYSE weren’t immediately available to say what might be different about the new plan.
What is clear is that the rule would essentially override FINRA’s pre-existing Rule 5250 that prohibits fund sponsors from paying someone to act as a market maker on its behalf. The rationale of 5250 is that market makers should do their jobs without the influence of an extra paycheck.
The NYSE Arca has wanted to implement a pilot program that would create a fixed financial incentive program for issuers of certain ETPs, arguing that rewarding market makers is imperative for the well-being of the market. Issuers would have the option of paying $10,000 to $40,000 a year per fund in incentives aside from regular listing and annual fees, again, the same amount detailed in the previous proposal that it abandoned.
The core issue at play is a lack of liquidity in most of the 1,400-plus U.S.-listed ETFs. In the decentralized electronic trading system that prevails in today’s markets, market makers have little reason to ensure tight bid/ask spreads and to generally keep trade in the majority of funds going smoothly when markets turn choppy.
What a market without market makers looks like was abundantly clear during the “flash crash” of May 6, 2010. On that day, which began with the market on tenterhooks as Greeks rioted in the streets of Athens, the stock market became unhinged, and market makers largely ran for cover as the market plunged.
The Dow Jones industrial average dropped 10 percent, only to retrace most of those losses—all in about 30 minutes. It ended up closing 4 percent lower and, crucially, about two-thirds of the securities that ended up having canceled trades that day were ETFs.
“The Exchange believes that the assignment of an LMM, which is held to higher standards as compared to Market Makers and other market participants, is a critical component of the promotion of a consistent, fair and orderly market in ETPs on the Exchange,” NYSE Arca said in the filing.
“However, market participants may be forgoing LMM (lead market maker) assignments in ETPs because the incentives to serve as an LMM are insufficient to outweigh the obligations, minimum performance standards, and other risks,” it said, again, rehashing verbiage contained in its previous round of paperwork.
Officials at the NYSE weren’t immediately available to clarify what was different, if anything at all, between the new proposal and the one it abandoned early in January of this year.
The NYSE Arca program isn’t necessarily the most lucrative for market makers.
If the Nasdaq gets a green light on its proposal currently in comment phase with the Securities and Exchange Commission, issuers would be able to put as much as $50,000 to $100,000 per ETP per year in the hands of lead market makers who perform well on their behalf.
The Kansas City, Mo.-based BATS Exchange also has an incentive program that it launched back in February, but it’s BATS rather than issuers who are footing the bill and paying market makers out of their pocket.
Investors have fewer—but better—choices.
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