Post-crisis changes in global finance are adding urgency to the debate.
Major banks like Goldman Sachs Group Inc. have stepped away from some types of ETF market-making because of increased regulation and scrutiny following the 2008 financial crisis. Technology-driven firms like Susquehanna International Group and Jane Street Group have taken their place, but some question whether they’ll hang around in times of stress.
“These market-makers that are new, technology-enabled trading firms, they don’t have balance sheets the size of the banks, and therefore they can step away for some time when the return associated with the trade doesn’t justify the risk in taking it,” said Fadi Abdel Massih, an analyst at Moody’s. “That’s when the liquidity issue can arise.”
Widespread Support
Finra floated the prospect of allowing direct payments to market-makers in 2017, with nearly three-quarters of respondents to an industry consultation supporting it. A version of the idea was even implemented in 2013, but “there was limited demand from market-makers to participate,’’ said Citi’s Odette. “The incentives were probably not strong enough.’’
A spokesman for Finra declined to comment.
Vanguard Group and State Street Corp. have expressed concern that paying ETF market-makers will ultimately hit investors’ wallets by translating into higher fees. Alternative proposals include cutting the minimum amount of ETF shares needed to create or redeem a fund, an idea that could ease traders’ costs by reducing their inventory. Market-makers work with institutions known as authorized participants to meet demand for ETF shares.
Of course, there are those who say everything is fine -- that the products have already proven their resilience in significant routs and that fears of a liquidity crisis are scaremongering. Eric Balchunas, an analyst at Bloomberg Intelligence, points out that few known issues have arisen amid billions of trades.
“The mechanism seems to be working well,” said Dimitris Melas of MSCI Inc. “I don’t see any reason why authorized participants, market-makers and the whole framework of creating and redeeming ETF shares or trading in ETF shares wouldn’t work going forward.”
--With assistance from Michael Msika.
This article was provided by Bloomberg News.