Curatia Analysis for Mon, Nov 14, 2022
Nasdaq Strengthens Auction Investor Protections, Forges ETP Liquidity Framework for Market Makers in Volatile Trading Age Sponsored
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Danielle Rutsky
ETF Senior Product Manager, Nasdaq |
An era of resurgent volatility is fueling liquidity concerns, prompting investors to embrace exchange-traded products offering intraday trading, superior liquidity, and muted price swings relative to individual stocks.
Against that backdrop, Nasdaq is reinforcing its reputation as the world's most technologically advanced exchange with enhancements designed to create a robust framework for ETP liquidity and protect investors from price swings that could lead to unfavorable execution in opening and closing auctions.
New Trading Environment
The Federal Reserve’s regime of rate hikes has made volatility a defining feature of markets in 2022. So far this year, the VIX has closed below its long-term median of 17.70 on just three trading days.
Intraday swings have also become routine as investors scour economic reports, parse Fed speeches, and pore over earnings transcripts for clues to the economy’s current tilt and central banks’ next moves and adjust their holdings accordingly.
The trends have encouraged investors to embrace the ability to trade ETPs intraday while turning away from mutual funds that only allow trading at the closing price. While US ETFs logged net inflows of nearly $500B YTD through October 26, mutual funds tallied net outflows of $790B.
Investors are also trading ETPs more because they typically offer lower volatility than individual stocks and liquidity in many cases superior to that of their underlying assets. US ETF volumes approached 30% of total equity volumes in September, a four-year high.
ETPs’ allure in volatile markets is encouraging new launches in 2022. ETF launches this year are on pace with 2021’s record tally — an impressive trend given the stark contrast between last year’s bull market and this year’s slide in equities, bonds, and cryptocurrencies.
At the same time, volatility has pushed trading volume into auctions as investors seek price discovery, price stability, and certainty of execution. Nasdaq’s 2022 Russell rebalance, for instance, saw a 40% YoY increase in shares executed in the closing cross. Opening auctions have meanwhile gotten a boost from the retail-trading boom.
Market experts expect volatility to carry over into 2023 as markets grapple with continued uncertainty surrounding stubborn inflation, the war in Ukraine, and the implications of numerous election results.
Enhanced Investor Protections
Markets’ volatility has added risk for individual investors and trading firms. To minimize that risk and market impact when trading, market participants have turned to Nasdaq auctions as a go-to source of liquidity.
Their trust and faith is due in part to Nasdaq’s enhanced auction process, which incorporates logic to ensure auctions are executed at the best prices available in the prevailing market context. Price protections around opening and closing auctions ensure markets function smoothly while shielding traders from risks associated with abnormal price deviations.
Starting August 1, the exchange tightened its collar protections for trades executed on Nasdaq-listed ETPs in its opening and closing auctions. Auction collars place upper and lower bounds on the prices of orders accepted into the opening and closing crosses.
Tightening them for ETPs, which tend to be less volatile than stocks, reduces the risk that aggressively priced orders will affect an auction price.
Nasdaq narrowed the percentage it uses to calculate Nasdaq listed ETP collars to 5% in the opening auction. The exchange likewise uses the 5% threshold in the closing auction for ETPs priced at $50 and below; for those priced above $50, it uses a 3% threshold.
Additional opening price checks, on top of collars in opening auctions, have helped protect investors by preventing opening prices from dislocating in times of overnight volatility – a feature unique to Nasdaq.
Nasdaq’s limit-up/limit-down hybrid close meanwhile applies ETP collars to closing auctions in which a security enters a limit-up/limit-down state after 3:50pm, providing further protections available only through Nasdaq.
In addition, Nasdaq distinctively applies midpoint price bands onto the Nasdaq bid and offer rather than back onto the midpoint to establish collar thresholds. The refinement maximizes price discovery, ensuring that auctions include orders close to an ETP’s fair value even if the spread is skewed. Nasdaq’s thresholds feature less tiering than other methodologies, simplifying life for market makers.
Enhanced protections empower investors to trade ETPs in Nasdaq auctions with confidence knowing there is logic in place to ensure good outcomes while promoting liquidity – a key consideration for newly launched ETPs.
Supporting ETP Liquidity
Nasdaq is also forging a robust framework to support ETP liquidity that will help issuers get new offerings off the ground as well as allow existing ETPs to thrive.
As with investor protections, much of that effort is unfolding in auctions. Previous Nasdaq enhancements provided transparency and flexibility by disseminating indicative opening and closing cross prices and share amounts while auction orders are still being accepted. The innovations let ETP Designated Liquidity Providers (DLPs) enter stabilizing orders more efficiently in response to indicated price dislocations due to temporary imbalances in supply and demand.
Nasdaq has built on the success of that initiative with its new Extended Trading Close (ETC) order type, which lets investors trade ETPs at the Nasdaq closing price for five minutes after the closing cross. The ETC order type is a potentially invaluable tool for allowing institutions to trade sizable orders with minimal market impact.
The exchange is also promoting ETP liquidity throughout the trading day with updates to its DLP program, which incentivizes market makers to provide liquidity across Nasdaq markets. It is increasing incentives for ETPs, with an emphasis on less liquid ETPs to promote market quality for newly launched and thinly traded ETPs.
Nasdaq has instituted enhanced market-quality requirements including ensuring DLPs quote prices within narrower spreads and provide a higher share of quotes at or near the National Best Bid and Offer (NBBO). It formalized the Secondary DLP role to further increase liquidity support for lower-ADV ETPs.
And most recently, it introduced an auction quality requirement to incentivize market makers to be involved in orders leading up to and during the auctions to keep prices closer to fair value.
Market makers can also earn rewards for activity across ETPs. Primary DLPs that take on a significant number of ETP assignments are rewarded on volume in all Nasdaq-listed ETPs.
Additionally, Nasdaq has reduced fees for any member liquidity provider that achieves Qualified Market Maker status by reaching a volume threshold or quotes at the NBBO in more than 1,000 securities for a portion of the day.
Taken together, the enhancements form a trading ecosystem that helps newly launched ETPs take flight, promotes liquidity in mature ETPs, and protects investors from unfavorable execution in auctions. They demonstrate a commitment to high-quality markets for ETPs that places Nasdaq at the forefront of one of markets’ key unfolding innovations.
And, most importantly, they help ETP issuers, market makers, and investors alike achieve better outcomes.