Communications, Capital Commitments
Designated Market Makers in Action: Four Scenarios
Designated Market Makers or DMMs are central to the NYSE and NYSE American market model. They operate both manually and electronically to facilitate price discovery during market openings, closings and during periods of substantial trading imbalances or instability. This "high touch" approach is illustrated in the following four case studies.
- Capital Commitments: As part of their responsibility to maintain a fair an orderly market, Designated Market Makers regularly commit capital to add liquidity to the market, and to bridge the gap between supply/demand. At times, this commitment can be quite large. For example, on the close of a recent Russell rebalancing day (a Friday), a DMM published to the market 13 million shares of a large cap DJIA stock to buy. Just prior to the close, an influx of sell orders caused the imbalance to swing to a 4 million share sell imbalance. In this situation, the DMM decided to commit $63 million in capital to support the stock at the close, avoiding a 2% drop in the price and $3 billion loss in market cap.
- Market Integrity: DMMs apply keen judgment to markets primarily driven by electronic trading. This judgment regularly sorts out erroneous trades which could otherwise result in severe volatility. For example, prior to a recent close, a DMM received a 15 million share buy order, which represented almost 5 times the average daily volume in that particular issue. The DMM recognized the order was peculiar as there was no news on the issue, and no offers available to satisfy the demand. The DMM promptly alerted the operations staff, who subsequently halted the stock and contacted the broker-dealer. It was determined that the order was sent in error to the wrong security and was subsequently cancelled. This fast action averted what could have amounted to millions of dollars in trading losses, as well as a mispriced close.
- Communications: Designated Market Makers communicate trading information to clients on a regular basis, as well as when situations warrant. For example, a listed company was directly attacked by a rival on its investor day, as well as in a targeted ad campaign and on the web. The listed company’s DMM firm was in constant contact with the listed company management regarding market participants, volumes and volatility. Also, as a result of the elevated volume, the DMM firm chose to increase its participation in the listed company by one-third, helping to mitigate excessive volatility in the stock.
- Special situations: Events such as earnings announcements, lock-up expirations and follow-on transactions necessitate additional care from the DMM to reduce potentially volatile impacts. For example, upon a recent lock-up expiration for an issuers' stock, its DMM recognized the risk to the company’s market cap, and decided to participate on 80% of the volume at the open. This represented a capital commitment four times more than usual. It resulted in better market for quality as well as improving the price to the sell-side and decreasing volatility at the open.