Arca, the New York Stock Exchange’s electronic trading platform, this week launched its market-maker incentive program covering certain exchange-traded products, fulfilling its aim to roll the program out after more than a year of fine-tuning it. Regulators in June approved the program, which is designed to ensure smoother trading of less liquid ETFs.
Under the optional pilot program that will last at least a year, issuers can choose the amount they would like to pay—between $10,000 and $40,000 per ETP annually—to be a part of the program. Lead market makers (LMMs) will get fixed quarterly payments, rather than variable enhanced transaction rates, in return for meeting monthly LMM quoting obligations, the NYSE said.
At the end of the one-year period of the pilot program the exchange has said it would determine whether to continue, discontinue or modify the incentive program, or make it permanent. The program applies only to ETPs with primary listings on the NYSE.
The plan essentially overrides the Financial Industry Regulatory Authority’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 had been that market makers should do their jobs without the influence of an extra paycheck.
The NYSE Arca had 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.
The core issue at play is a lack of liquidity in most of the 1,500 U.S.-listed ETFs. In the decentralized electronic trading system that prevails in today’s markets, market makers have had little reason to ensure tight bid/ask spreads and to generally keep trade smooth in the majority of funds 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 in a few minutes, 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 Securities and Exchange Commission, in its approval , said the program the exchange put forth is “NYSE Arca Equities Rule 8.800,” and that the NYSE proposed amending fee schedules under the rule.
The NYSE Arca program isn’t necessarily the most lucrative for market makers.
If the Nasdaq gets a green light on its proposal with the SEC, issuers would be able to put as much as $50,000 to $100,000 per ETP per year in the hands of LMMs 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.