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In April 2021, the NYSE enhanced its industry-leading ETF Liquidity Program by introducing new requirements and incentives for additional market makers (“Less Active ETF Leads”) for new and/or low-volume ETFs listed on the NYSE. After having already studied the initial market quality effect of this initiative, we reexamine the issue at the program’s 1-year anniversary during a period of surging market volatility.
Consistent with our earlier findings, ETFs with assigned Less Active ETF Leads continue to enjoy tighter spreads, greater quoted size, and lower daily price volatility than peers. Amid periods of surging market volatility, Less Active ETF Leads provide an additional layer of market quality support for these ETFs, which see their market quality lead over peers skyrocket particularly during times of market stress.
In our initial examination of the NYSE ETF Liquidity Program enhancements in November 2021, we found that ETFs with Less Active ETF Leads saw their daily spread and price volatility significantly tighten, while their quoted size increased substantially over peers. Now more than a year since the inception of Less Active ETF Leads, these market quality benefits remain very strong. Market volatility has increased quoted bid-ask spreads across the board; despite this, the median daily spread of ETFs with a consolidated average daily volume (CADV) of less than 50k shares tightened by 11% (Figure 1) and higher-CADV groups tightened by ~7%1. All three CADV groups saw their median daily size increase by over 100%, while daily price volatility decreased by as much as 20% for thinly-traded ETFs (Figure 1). Moreover, a staggering 90% of all ETFs with an assigned Less Active ETF Lead saw their average posted size within 1% of the NBBO increase post assignment (Figure 2).
Change in median daily spread*, daily quoted size with 1% of the NBBO and daily price volatility* after assignment of Less Active ETF Lead - broken down by CADV group
Ratio of average quoted size within 1% of the NBBO before Less Active Lead assignment over average quoted size after assignment broken down by CADV group - each bar represents a listed ETF that received a Less Active ETF Lead before 05/31/2022.
Tighter spreads, greater quoted size and lower price volatility (1) minimize the chance of poor executions for new and low volume ETFs, potentially lowering the cost of investment, (2) encourage new investors to enter ETFs with higher-quality trade 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, helping new investors find immediate execution in the marketplace.
Amid numerous spells of surging market volatility in 2022, ETF spreads have widened out to new highs, raising the risk of poor executions for investors. Throughout this time, ETFs with an assigned Less Active ETF Lead have showcased the significance of Less Active Leads in supporting excellent market quality in the ETF space. As shown in Figure 3, ETFs with assigned Less Active Leads are shielded from sudden spikes in spreads during periods of extreme volatility in equity markets, with the lead-induced spread protection amplified in times of heightened volatility. Less Active ETF Leads help protect thinly-traded ETFs from the risk of poor executions and Limit Up Limit Down halts during such extreme trading environments.
Median daily spread improvement for ETFs with with an assigned Less Active Lead broken down by CADV group against VIX (5-day MA)
The new enhancements to the NYSE ETF Liquidity Program have helped NYSE Arca solidify its position as the leading listing venue for ETFs. With the additional market quality benefits from Less Active ETF Leads, ETFs listed on NYSE Arca maintain significantly tighter spreads and vastly greater posted size throughout the trading day than ETFs listed on any other venue (Figure 4).
Median daily spread and daily quoted size within 1% of the NBBO broken down by an ETF's listed venue and CADV group
Through the industry-leading NYSE ETF Liquidity Program, ETF issuers can boost liquidity and enhance market quality in their products. Even in periods of extreme market volatility when execution quality is especially challenged, Less Active ETF Leads provide a unique layer of support for new and/or thinly-traded ETFs, keeping spreads in check and boosting quoted size in the marketplace. Through continued innovation and enhancements, NYSE Arca continues to solidify its place as the leading listing venue and home of ETFs.
1 Spreads and price volatility calculations are SPY-adjusted; daily SPY spread and volatility is used as a baseline to de-trend data.
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