SEC Delays Market-Maker Ruling
July 19, 2012
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The Securities and Exchange Commission has delayed for now a decision on whether to OK Nasdaq’s and NYSE Arca’s proposed plans to allow fund sponsors to pay market makers incentives to help boost liquidity in many ETFs.
Instead, the regulatory agency decided to prolong the debate and invite additional public comment on the matter before it makes a final decision, according to a statement it issued on the matter earlier this month.
The issue at hand is whether to allow the two leading stock exchanges in the U.S. to create a system where ETF issuers would be allowed to pay market makers for keeping their ETFs liquid and the bid/ask spreads at which they trade tight, as Nasdaq and NYSE Arca detailed in plans submitted to the SEC earlier this year.
While differing in details, both plans overlap in their quest to override FINRA Rule 5250, which prohibits fund sponsors from paying someone to act as a market maker on their behalf. The rationale of 5250 is that market makers should do their jobs without the influence of an extra paycheck.
The broader context is that market making is a transformed business in the age of electronic markets. The “specialists” who once plied the floors of the New York Stock Exchange keeping order flow on designated stocks moving are largely a relic of the past. What’s replaced that commitment in the modern era isn’t clear.
Many fear that when markets turn volatile, today’s market makers simply go missing for fear of being caught in the middle of a plunge that could wipe out hard-earned profits in one fateful trading session. The proposed incentive plans are meant, in part, to keep market makers from fleeing the scene of a selloff.
Public Opinion Divided
During the first phase of public comment, the SEC said it received 18 letters on Nasdaq’s proposal, with 10 of them being in favor, seven against, and one undecided that included a request for additional time to mull over the issue.
Only three comment letters reached the SEC regarding NYSE Arca’s proposal, but the divergence in views was also evident: Two were largely for the program, one was against it, and many concerns were raised.
Those in favor of Nasdaq’s market–maker incentive program generally argued that better liquidity would be beneficial for the overall markets, reduce transaction costs and increase price discovery while decreasing volatility, the SEC said in the report.
The opposition, however, argued that Nasdaq’s program would “result in manipulation and an unfair market place,” as it would undo investor protections FINRA’s Rule 5250 was created to provide in the first place, the SEC said.
Whether the program would end up resulting in an environment where ETF providers have to “pay-to-play” and where funds that weren’t eligible for the program might get hurt was another point of concern, the report said.
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