As duly noted by industry expert TABB Forum, ETFs with little-known or illiquid underlying securities are a hard sell without liquidity.  “Whether you loved or hated them, major exchange specialists (including this blogger) played a vital role to help nurture small listings, and the problem of how to incent liquidity provision is an ongoing industry debate. Without an extra incentive, market makers don’t consider it worth the risk..”

NASDAQ apparently understands this challenge. As reported by TABB, and in a rule filing submitted to the SEC, the exchange that will soon be home to Facebook proposes to put ETF issuers in the driver’s seat by facilitating issuer payments to market-makers in consideration for those traders quoting and trading those pesky, “hard-to-trade” aka “illiquid” ETF products that seem to trade by appointment only.

According to the TABB piece, “..The rule filing is waiting to be ‘noticed’ by the SEC, which will start turning the wheels of the rule filing and formal commentary process. If ultimately approved, the writing is on the wall for equities.There is little on the regulatory table at the moment to improve market quality, but prior success of a similar program abroad and political concern over how to improve the lot of smaller securities at least gives this proposal a decent chance of making it to the pilot…”

Not everyone fully agrees. At least one former ETF market-maker who was invited by NASDAQ to help formulate their new proposal believes it could open Pandora’s box (even if some think the Genie is already out of the bottle..) Continue reading →