Exchanges May Be Losing Grip On ETFs

August 09, 2013

How tradable an ETF is may depend on where you trade it.

Earlier this week, Dave pointed out that medium-to-low-liquidity ETFs face tradability issues when there’s a steep drop in volume. That was only part of the story.

It’s also crucial to point out that exchanges are losing ground when it comes to volume market share. As a result, looking at the order book for a particular ETF on any given day likely gives only a hint of the available liquidity—especially in ETFs.

Since the “flash crash” of May 6, 2010, ETF market makers have been more cautious of their quotations for ETF products on exchanges.

As a result, there’s often more liquidity available for any given ETF than otherwise might be seen on-screen. In the age of high-frequency trading, market makers face more risks getting picked off in their quotes, so it makes little sense to post the available size you’re willing to trade as a market maker.

However, investors have also sought off-exchange platforms to execute their orders. These off-exchange venues include dark pools, broker pools, agency brokers, upstairs market makers, liquidity providers and alternative trading venues, and they’ve all taken a chunk of market share from exchanges.

The question is, To what extent have investors utilized off-exchange venues (i.e., working directly with liquidity providers, dark pools, etc.), especially during periods of low volume?

Consolidated ETF Volume

The chart above provides a little glimpse into the mechanics of ETF-specific trading volume. The red bars represent ETF consolidated volume from all venues ranging from Nasdaq to NYSE Arca to agency-brokered orders.

The blue bars represent ETF volume as reported through the Trade Reporting Facility—a means of gauging off-exchange volume of exchange-listed securities. The green line represents the percentage of the consolidated ETF volume that is traded off-exchange.

So what’s the takeaway here?




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