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Data Insights

Enhancing ETF Market Quality:

An Analysis of NYSE's ETF Liquidity Program

Stefanos Bazinas
Execution Strategist, NYSE

November 8, 2021

As the home of ETFs, the NYSE continuously works to strengthen market quality and provide the optimal trading environment for listing and trading ETFs. In April 2021, in service of this goal, the NYSE introduced new requirements and incentives for its industry-leading NYSE ETF Liquidity Program, including the assignment of additional market makers ("Less Active ETF Leads") for new and/or low-volume ETFs.

After more than half a year in-market, the NYSE Research team has analyzed the market quality impact of this initiative, with key findings for ETFs with assigned Less Active ETF Leads including:

Market quality up across the board, especially in thinly traded ETFs

Our analysis of the impact of Less Active ETF Leads studied the market quality metrics of new or thinly traded NYSE Arca-listed ETFs both before and after Leads were assigned.

These market quality metrics include spread1 and quoted size2. Tighter spreads and greater quoted size (1) minimize the chance of poor executions for new and low volume ETFs, thus lowering the cost of investment, (2) encourage new investors to enter ETFs without impacting trade quality execution and (3) help reduce market risk by reducing the probability of a Limit Up Limit Down halt and ensuring that large orders do not outsize the order book, so that new investors can find immediate execution in the marketplace.

Figure 1 shows median spread and quoted size data since January 1, 2021, for those NYSE Arca-listed ETFs with an assigned Less Active ETF Lead as of November 1, 2021. Overall, median spread improved by 3bps while quoted size increased across the board by more than 10k shares. The largest increase was seen in thinly traded symbols with a consolidated average daily volume (CADV) of less than 50k shares, where spreads tightened by as much as 3.7bps (-19%) and quoted size reached levels 3.3x times higher than before the assignment of the Less Active ETF Lead.

Figure 1

Market Quality Pre/Post Less Active ETF Lead Assignment

Median spread and quoted size by CADV bucket - includes symbols which currently have at least one assigned Less Active ETF Lead

Having only one Less Active ETF Lead on an ETF, particularly if it is thinly traded, does not necessarily maximize the potential market quality and liquidity benefits. Figure 2 shows the median spread and quoted size post-assignment outperformance ratio3 broken down by the number of assigned Leads. ETFs with more than one assigned Less Active ETF Lead outperform, with spreads tightening to as much as 74% of their pre-assignment widths. ETFs with one assigned Less Active ETF Lead still outperform versus their pre-assignment spread values, but not to the same extent as ETFs with multiple Leads. Similarly, for quoted size, ETFs with multiple Less Active ETF Leads outperform their one-Lead counterparts by more than 100%, with the gap widening since the August 1 wave of Less Active ETF Lead assignments.

Figure 2

Market Quality by # of Less Active ETF Leads

Median ratio of each ETF's spread and quoted size over the ETF's average no-lead spread and quoted size since Jan 1st, by number of assigned Less Active ETF Leads

Spread and depth improvement persists through time as market participants adapt

The ETF Liquidity Program enhancements have brought sustained improvements to market quality. Figure 3 shows weekly median spread and quoted size fluctuations across time for ETFs based on their current (as of November 1) Less Active ETF Lead assignment status. Spreads for ETFs that currently have an assigned Less Active ETF Lead have consistently tightened throughout 2021, overtaking the no-Lead group since mid-September. Similarly, for quoted size, ETFs with at least one assigned Less Active ETF Lead have seen a consistent increase in their quoted size throughout 2021, with the outperformance starting in June 2021 as market participants adjusted to the new enhancements.

Figure 3

NYSE Arca Spread & Quoted Size Trend

Weekly Median Spread and Quoted Size

"With Less Active ETF Lead" includes symbols which currently have at least one assigned Less Active ETF Lead

New incentives provide added price support

In addition to spreads and quoted size, price volatility4 has also improved with the ETF Liquidity Program enhancements. Figure 4 compares median daily price volatility for NYSE Arca-listed ETFs before and after a Less Active ETF Lead assignment. Overall, price volatility decreased by 1.3bps (-28%) after the assignment of a Less Active ETF Lead, with ETFs trading under 150k shares daily in CADV seeing their overall price volatility improve by more than 29% across both corresponding CADV buckets.

Figure 4

Daily Price Volatility Pre/Post Less Active ETF Lead Assignment

Median daily price volatility by CADV Bucket - includes symbols which currently have at least one assigned Less Active ETF Lead

NYSE Arca expands its primary listing lead

The new requirements and incentives in the NYSE’s ETF Liquidity Program have further distinguished NYSE Arca as a primary listings exchange (Figure 5).

With the Program changes, both LMMs and Less Active ETF Leads have increased NYSE Arca’s market quality outperformance compared to other listings venues. In aggregate for October 2021, NYSE Arca-listed symbols with an assigned Less Active ETF Lead had spreads 13% tighter than the next best exchange. Moreover, NYSE Arca has taken the number one spot in terms of lowest median daily price volatility for ETFs with an assigned Less Active ETF Lead since the enhancements were implemented in April 2021.

Figure 5

Spread and Price Volatility by Exchange

Median Spread and Price Volatility by Exchange since 01/01/2021

"NYSE ARCA - w/ Less Active ETF Lead" includes symbols which currently have at least one assigned Less Active ETF Lead

A new avenue to boosted liquidity and enhanced market quality

The NYSE ETF Liquidity Program provides a new and improved avenue for ETF issuers to boost liquidity and enhance market quality in their products. With Less Active ETF Leads, issuers can now access tighter spreads, lower price volatility and increased quoted size - all of which are especially crucial for thinly traded ETFs. This new normal has widened the market quality gap between NYSE Arca and its competitors, providing superior liquidity conditions for issuers and investors.

1 Average consolidated spread throughout each trading day (measured in bps).
2 Number of shares within 1% of the prevailing NBBO on listing's primary exchange (measured in number of shares).
3 Post-assignment outperformance ratio defined as the ratio of an ETF’s spread (quoted size) over the ETF’s average spread (quoted size) between January 1st, 2021 and the last day it did not have an assigned Less Active ETF Lead.
4 Calculated as the difference between each symbol’s daily high and low price relative to the mid price (measured in bps).

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