Goldman Sachs Group Inc. is pulling back substantially from trading that helps backstop the fast-growing use of U.S. exchange-traded funds, giving smaller firms an opportunity to grab market share.
Goldman has told fund providers it is scaling back its role as a top lead market maker (LMM) for ETFs and has already slashed the number of funds it supports in that capacity, according to disclosures, fund managers and other trading firms this month.
Relatively high regulatory and other costs of operating as an LMM prompted the pullback by Goldman, one of the few large banks remaining in that role, some people said.
A spokeswoman for Goldman declined to comment on the bank's market-making business.
The move signals the shifting landscape of making markets in many assets away from traditional broker-dealers towards smaller, electronic-focused upstarts.
LMMs are critical to keeping ETFs trading smoothly. While brokers-dealers can typically trade as they please, firms acting as LMMs must consistently offer competitive buy-and-sell quotes in their assigned ETFs, and they receive rebates on exchange fees. Some also provide start-up financing for the funds.
The LMMs risk some of their own capital to buy and sell ETFs to help maintain their liquidity. Unlike smaller rivals, big banks like Goldman Sachs are subject to strict capital requirements by regulators, putting them at a disadvantage when it comes to costs in an already low-margin business.
ETFs attracted a record $348 billion globally in the first half of this year, compared to $123 billion at the same point last year, according to research service ETFGI LLP.
Despite the skyrocketing growth in ETFs, it can be hard to translate the LMM business into a high-margin operation.
Market making is a technology business as much as a trading enterprise, and involves finding the right price for funds holding dozens of stocks or bonds in a split second while making other trades to manage risk.
One industry veteran described the business as "scraping fractions of pennies all day."