NYSE, Nasdaq Revise Price-Quote Rules to Help Ensure Sufficient Liquidity
NYSE Euronext and Nasdaq OMX Group Inc. are increasing price-quoting requirements for some market makers to help ensure adequate liquidity, as regulators and exchanges try to prevent another crash like the May 6 retreat.
Nasdaq Stock Market now requires brokers that want to qualify for its select market-maker, or SMM, program to quote at a security’s best price at least 10 percent or 15 percent of the day, based on a stock’s average volume. The New York Stock Exchange will strengthen quotes rules for nine firms next month.
“Events on May 6 highlighted the fact that there’s a real risk of liquidity disappearing in certain stocks,” said Kumar Venkataraman, a professor at Southern Methodist University Edwin L. Cox School of Business in Dallas who studies trading in the equities and bond markets. “Issuers and other participants want to know what exchanges are going to do to make sure this doesn’t happen again.”
Regulators and exchanges are working to enhance the trading obligations of market makers following the May 6 rout that erased $862 billion in equity value in about 20 minutes as some firms reined in the liquidity they were providing. The changes by NYSE and Nasdaq specify the minimum time each day that firms must be at the national best bid or offer -- known as the NBBO - - the highest price at which mutual funds and investors can sell and the lowest at which they can buy shares on any market.
‘More Meaningful’ Rules
Nasdaq’s updated requirement “is more meaningful to issuers” than the old rule that SMMs be 0.2 percent of the volume in that stock and quote within a range of the NBBO, said Frank Hatheway, chief economist at Nasdaq OMX, who’s based in Rockville, Maryland. “It’s stricter.” SMMs previously had to quote within 2 percent of the NBBO half the time for the most actively traded stocks.
“We’re trying to enhance the amount of liquidity we have in the market” at the NBBO, Hatheway said.
The top SMM firms among the more than 50 in the old program have been quoting at the NBBO at least 10 percent of the time in most of the companies on their list, he said. Others supplying bids and offers at the NBBO less than 10 percent of the time would have to quote more at the best price to continue to qualify. The SMM program began in 2007.
NYSE’s supplemental liquidity provider, or SLP, program doubles to 10 percent the portion of the day the exchange’s nine participating firms must quote at the NBBO. The new requirements go into effect Oct. 1 for the liquidity providers, which include Goldman Sachs Group Inc. in New York, units of Chicago-based Citadel LLC and Getco LLC, and a New York unit of London-based Barclays Plc.
‘Raises the Bar’
The proposal “raises the bar on the liquidity that SLPs add to the market,” said NYSE spokesman Ray Pellecchia. “The SLPs already meet or exceed these requirements for many of their securities.” NYSE’s changes, which must be approved by the Securities and Exchange Commission, also require SLPs to trade 10 million shares a day.
The more-onerous requirements for NYSE’s five designated market makers, or DMMs, which oversee activity in their assigned stocks and have quoting and trading obligations that aren’t imposed on SLPs, aren’t changing. Both sets of brokers get better pricing on NYSE than do other trading firms. SLPs accounted for 12.4 percent of NYSE’s volume in July, down from 13.3 percent in June, according to the exchange.
Nasdaq Vs. NYSE
“Nasdaq is trying to strengthen the obligation of its market makers so it appears more favorably in light of NYSE’s DMMs,” said Patrick Healy, a former executive at Bear Stearns Cos.’s specialist unit who now runs Chevy Chase, Maryland-based Issuer Advisory Group LLC, which provides consulting to publicly traded companies. “NYSE counterpunches. It’s about competition for the survival of their market models.”
He said Nasdaq’s SMM program “had no teeth” since there were no consequences for firms that didn’t meet their obligations. NYSE in October is adding penalties for SLP firms that fail to meet their quoting requirements.
The exchanges are relying on different approaches to spur more quoting at the NBBO, which attracts more trading volume. Nasdaq gives SMMs no trading advantages, while NYSE’s rules for its market are based on a set of obligations and benefits for certain participants.
“Nasdaq’s pricing is based on trading activity and where you stand in execution priority is based on when you arrived in the market,” Hatheway said about rules that determine how orders transact. “There is no status and pricing differential tied to SMMs.”
NYSE’s DMMs can execute before orders at the same price from other firms that were submitted to the exchange earlier, one of the benefits DMMs get for the added quoting and trading obligations they face on the New York exchange.
“Exchanges compete on market quality,” Venkataraman said. “So if an exchange can put together a market structure such that spreads are tighter and it has more depth, it can use that as a marketing tool to attract new listings.”
To contact the reporter on this story: Nina Mehta in New York at nmehta24@bloomberg.net.
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