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ETF Market Quality Improved Under ASX Scheme – CMCRC

Capital Markets Cooperative Research Centre (CMCRC), the Australian independent academic centre for capital market research, has found that trading activity and market efficiency in the Australian ETF market, which is approaching $7B, have improved following the introduction by the ASX of the ETF Market Making Scheme. 

The study was conducted by by Dr Elvis Jarnecic, Research Director, Financial Markets Research Centre of the CMCRC, and Professor David Michayluk and Jagjeev Dosanjh of the University of Technology, Sydney. It looked at the impact that the scheme, introduced in 2010 to enhance the ETF market, had on market efficiency and trading.  The authors analysed market activity over a period of 12 months either side of the introduction of the scheme, to assess the impact of market maker rebates for meeting spread and volume requirements. To qualify for the rebate, contracted market makers had to meet obligations 80% of the time over a calendar month, the rebate covering all trading and clearing fees.  Secondly, the study looks specifically at the trades made by the market makers to see how income is derived and whether they supply liquidity.

Dr Jarnecic says “our results indicate that market makers are net suppliers of liquidity and are therefore fulfilling their mandated duties. In the year following the scheme, profits generated from supplying liquidity are significantly greater than position-taking profits”.

The study also confirmed that the rebates themselves are responsible for these enhancements.

Dr Jarnecic says that multivariate analysis confirms “while market liquidity has been enhanced following the introduction of the scheme, improvements in both bid-ask spreads and depth are most pronounced in periods when rebates are paid”.

There have been public arguments against market maker obligations in recent years, because high frequency traders are the most active market makers but often have no obligation to maintain a market presence. Many papers studying the growth of algorithmic trading show the benefits HFT has on market quality, leading to question whether designated market makers are necessary.  However, during periods of markets stress, liquidity providers are needed and designated market makers fulfill market requirements during this time.

The overall conclusion from the study indicates that the changes to the market maker scheme have increased trading activity and ETF market efficiency and ultimately made a positive contribution to market quality. Reporting on the findings, Dr Jarnecic says “Liquidity improvements are accompanied by consistent changes in actual trading outcomes, indicating that the scheme has been successful in improving quoting behaviour as well as affecting trading activity”.

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