August 11, 2016
Back on June 12, 2013, NYSE Arca was granted approval by the SEC to initiate a pilot program where they would pay market makers to add liquidity in thinly traded exchange traded products (ETPs). NYSE Arca describes this program as:
"The ETP Incentive Program is designed to improve the quality of market for lower-volume ETPs, thereby incentivizing them to list on the Exchange.
Under this optional program, issuers are given the flexibility to choose the amount they would like to pay, between $10,000 and $40,000 per ETP annually, to be a part of the program. LMMs get fixed quarterly payments, rather than variable enhanced transaction rates, in return for meeting their monthly LMM quoting obligations."
NYSE Arca has just filed for yet another extension of this incentive pricing pilot program which was set to expire on September 4th, 2016 (they have already been granted two extensions by the SEC). We wrote about this program back in September 2013 and questioned why NYSE was trying to support ETPs that were failing. We wrote:
"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."
Our opinion is that incentive programs for ETPs do not help the overall market and should not exist. NYSE's own Assessment Report (which the SEC required them to do after their last extension) had this to say about their ETP Incentive program:
"The Assessment Report assessed whether the ETP Incentive Program has met its proposed goals to incentivize market makers to take LMM assignments in certain lower-volume ETPs. The Assessment Report concluded that, while the results in certain cases show strong evidence of higher market quality in some ETPs based on participation in the ETP Incentive Program, the data is less conclusive for other ETPs due, in large part to the limited data available. Therefore, the Assessment Report concluded that it is difficult to state conclusively whether the Incentive Program has met its objectives."
We expected to see in the Assessment Report information such as volume, spreads, percent of time lead market makers were on the bid/offer for dozens if not hundreds of ETPs that were in the incentive program over the last three years. However, we were surprised to find out that the program only contained 3 ETPs (CRBN, HYGH and DVYA). Why should the SEC grant another extension to a program that has clearly showed very little interest? The market is telling the SEC that there is no need for an incentive program to exist for ETPs.
In addition to NYSE, other exchanges also have their own incentive programs which look to prop up failing ETPs. In fact, Nasdaq has also recently filed to juice up the rebates they pay to market makers to incentivize them to add liquidity. According to Reuters:
"Under Nasdaq's changes, which take effect on Sept. 1, market makers will earn rebates of 36 cents to 47 cents per 100 shares traded, depending on the volume of the ETP. Current rebates of 40 cents to 46 cents are not tied to trading volume. Firms may also receive rebates of up to 70 cents per 100 shares on new ETPs."
We urge the SEC to review NYSEs own assessment data and to stop granting approvals for ETP incentive programs. The market has spoken and it is saying that it does not need any more payment for order flow programs.
Thank you for your consideration.
Themis Trading LLC