The battle among the three main U.S. stock exchanges for volume and issuance of exchange-traded products has meant lower costs for issuers and market makers, but asset owners using ETPs should take note that such competition could impact best execution and heighten volatility.
ETPs are issued on a single exchange but can trade on the secondary market across several venues both on and off exchanges. Both listing and trading business is being actively courted by Intercontinental Exchange Inc.'s NYSE Arca, the Nasdaq Stock Market and BATS Global Markets Inc. and has spurred a number of incentives from all three to attract more market share, both for issuance and for trading volume. In the latest moves, BATS on Oct. 1 introduced ETF Marketplace, which offers to pay issuers as much as $400,000 a year to list ETPs on its exchange, with payments based on average daily volume. That same day, NYSE Arca reduced fees for issuers and added price incentives for lead market makers. Nasdaq instituted its own lead market-maker incentive program in July.
The money for these incentives is more than recouped by the increased volume on the exchanges, sources said.
“If (money managers) are compelled to use a venue because of their rebate, are they getting best execution?” asked Michael Falk, partner at Focus Consulting Group, a Long Grove, Ill.-based consultant to money managers. “And ultimately, since it's their investments that are being traded, is that exchange offering them what they need as a fiduciary? ... In all contracts (with money managers), there's always the same line requiring best execution. There's a duty to the client — but how does the client verify that it's being practiced? As a result, money managers must act to check any impropriety in selection of venues.”
These incentives have come at a time of concern over how ETPs impact overall markets. Mary Jo White, chairwoman of the Securities and Exchange Commission, said last month the agency is looking at how ETPs behaved Aug. 24, when markets lost more than 3% of their value as many ETPs traded at a sharp discount from their net asset value. Trading in more than 1,000 ETFs was halted because of automatic volatility limits.