NYSE Arca Has Withdrawn Their Controversial Proposal For A Lead Market Maker Issuer Incentive Program
We at Themis Trading are not financial news reporters but we do like to investigate market structure issues. Lately though, it seems that we have been breaking more news on our blog, and based on the visitor records of our blog, the media seems to like our work. Today, we have another breaking news story that seems to have overlooked.
NYSE Arca has withdrawn their controversial proposal for a Lead Market Maker Issuer Incentive Program aka the Fixed Incentive Program. Back on May 11, 2012, NYSE Arca proposed establishing a program which would essentially allow ETP (Exchange Traded Products) sponsors to pay lead market makers an incentive to trade and quote in their ETP’s. The NYSE Arca proposal stated:
“The Exchange proposes to add new NYSE Arca Equities Rule 8.800, which would offer a pilot program to incentivize Market Makers to undertake LMM assignments in ETPs. An issuer of an ETP that participates in the proposed Fixed Incentive Program would continue to pay the currently applicable Listing and Annual Fees. Such issuer also could elect to pay the Exchange an Optional Incentive Fee, which would range from $10,000 to $40,000 per year.”
The proposal wreaked of payment for order flow and the SEC twice issued an extension of the window allowed to approve or disapprove the proposal (by the way, Nasdaq has a similar outstanding proposal known as a Market Quality Program). The SEC was set to rule on this proposal by January 12, 2013 but NYSE Arca suddenly withdrew their request on January 9, 2013.
The SEC received eight comment letters on the proposal. The most critical letter was from Vanguard . Vanguard took issue with both the NYSE Arca and Nasdaq proposals for paying ETP market makers:
“Vanguard expressed many concerns about issuer-financed market maker incentive programs in our earlier comment letters. Briefly, those concerns include:
– Issuer payments to market makers have the potential to distort market forces, resulting in spreads and prices that do not reflect actual supply and demand.
– Issuer payments to market makers could lead to diminished market making activity and/or wider spreads in ETFs that are ineligible to, or choose not to, participate in the Programs.
– Issuer payments to market makers could create a pay-to-play environment, effectively forcing issuers to pay up to maintain quality markets for their eligible ETFs.
Another concern we have about issuer-financed market maker incentive programs is that they are likely to be detrimental to long-term buy-and-hold investors. Although the source of payment for both the Nasdaq and Arca Programs is the ETF sponsor, rather than the ETF, we believe it is likely that ETF sponsors would seek to recoup those costs in some way from the ETF and its shareholders. “
Now, we won’t question Vanguard’s motives for their stance, you can read into that one for yourself (think market share). By withdrawing their proposal, NYSE Arca has backed down from a very controversial proposal. Payment for order flow is already embedded in the equity market through the maker/taker pricing model. Adding another layer of payments through a Fixed Incentive Program for ETP’s would have just added more opportunities for “market makers” to create artificial arbitrage opportunities. Anybody want to wager that Nasdaq will withdraw their similarly controversial Market Quality Program after seeing NYSE Arca withdraw their proposal?