NYSE ETP Payment Program – Or Who the Heck Is Stinky (Ernie Weckbaugh)?
Who remembers watching The Little Rascals as young kids? Alfalfa… Spanky… Darla… Buckwheat… You still remember them to this day, don’t you? But the real question is do you remember Stinky – AKA Ernie Weckbaugh?
That’s ok; we did not either. [As an aside Weckbaugh went on to become a successful journalist, columnist, and author] We guess some rascals are meant to be remembered, and some perhaps less so.
It’s like that with ETPs as well. Some ETPs are well known, and very well traded, and some not so much. Everybody follows the SPYs and QQQs; but not everybody follows DIRT – a Pure Beta Agriculture ETN. Heck, there is even an ETF created by the Winklevii that tracks Bitcoin performance.
While the ETP industry has experienced exponential growth over the last decade, there are signs that perhaps some in the industry have gone overboard, and created way too many ETPs, many of which are somewhat murky and little understood [ONN and OFF for example?] Check out these factoids on the US ETP market:
– In the United States alone there are about 1200 ETPs alone, with AUM of approximately $1.3 trillion.
– Only 3% of US households own these ETPs.
– There are about 36 ETP sponsors/Issuers.
– Over the 2002-2012 period, ETPs have issued over $1 trillion in new shares.
– The industry is top heavy – ½ of the trillion dollar industry’s assets are held in just 25 of the more than 1,500 different ETPs.
While some ETPs have staying power and interest, many do not, and they are quietly shuttered. Natural Selection at its finest. This is a good thing, as the assets in those ETPs tend to get allocated to more efficient and desired assets. However, ETPs are first and foremost products designed to make the industry money. And money is made by the issuers, by market makers who act as ‘authorized participants”, and by the stock exchanges – who want the trading volume.
That brings us to what we wish to talk about today. Apparently that ETP trading volume is a much more important statistic you need to pay attention to than any of the other stats we mentioned earlier in the note.
NYSE Euronext recently proposed an incentive-payment- for-quoting program for ETPs designed to increase trading volume, liquidity, and “tighten spreads” for investors. The SEC approved this payment-for-order-flow program on September 3rd, which required an exemption from the 1934 Exchange Act.
Barron’s wrote about this program yesterday in an article titled No ETF Left Behind Begins at the NYSE. The crux is that NYSE will be collecting payments from ETF and ETN issuers, and then turn around and distribute those payments to members who will meet minimum thresholds in terms of quoting and trading the products. What are these minimum thresholds?
The Incentive Program requires LMMs to: (1) maintain continuous, two-sided trading interest where the price of the bid (offer) interest is not more than a designated percentage away from the then current NBBO; (2) maintain quotes or orders at the NBBO or better (the “Inside”) during the month during Core Trading Hours in accordance with certain maximum width and minimum depth thresholds based on daily share volume and share price, unless the thresholds are otherwise met by quotes or orders of all market participants across all markets trading the security; (3) maintain quotes or orders on NYSE Arca at the NBBO that meet either a time-at-the-Inside requirement or a size-setting NBBO requirement; and (4) for at least 90% of the time when quotes may be entered during Core Trading Hours each trading day, as averaged over the course of a month, maintain (A) at least 2,500 shares of attributable, displayed posted buy liquidity on the Exchange that is priced no more than 2% away from the NBB for the particular ETP; and (B) at least 2,500 shares of attributable, displayed posted offer liquidity on the Exchange that is priced no more than 2% away from the NBO for the particular ETP. If an LMM does not meet these quoting requirements, it will not receive an LMM Payment, and an LMM that does not meet or exceed these performance standards for any two of the three months of a quarter or for five months during the pilot period may lose its LMM status.
ETP trading volume is important to stock exchanges. It drives their profits in many ways. For example, HFTs arbitrage ETPs and their component securities – which creates volume. HFTs need speed to do this, and buy expensive data services from the exchanges to achieve that speed. The stock exchanges love that so many new ETP issues have been floated on their exchanges in the last decade. They do not want to see that volume go away. They do not want to see demand for their data service wane. They do not want the bubble to burst. Which is why when natural selection decides that some ETPs should close down (those that have little $AUM and little trading volume), the stock exchanges are trying things to thwart that natural process. CNBC commentator Joshua Brown nailed it yesterday, when he commented:
“The NYSE disavows capitalism and will now award “participant” trophies and offer liquidity to failing ETFs.”
The bottom line is that perhaps we were not meant to remember Ernie Weckbaugh (Stinky) as readily as we remember Spanky and Alfalfa. And that is ok. Wekcbaugh went on to better and more efficient uses of his time and energy.
This is what should naturally happen to un-demanded ETPs, for that is the nature of unencumbered free markets.