A potential takeover of Knight Capital Group (NYSE: KCG) would impact the exchange traded fund industry because the trading firm is one of the largest so-called authorized participants responsible for making markets in ETFs.
Knight is in negotiations to possibly sell its market-making unit, its largest business, The Wall Street Journal reported late Friday.
“If they sold the market-making business, it would make sense to sell simultaneously the other assets to them or somebody else. They don’t have a company once they sell that business. It’s the mainstay,” said Sandler O’Neill analyst Richard Repetto in a Bloomberg story over the weekend.
Knight is a key authorized participant, or AP, in the ETF business. APs provide a service by transacting with an ETF sponsor to manage the supply and demand of ETF shares in the marketplace, explains David Mann, head of regulatory affairs for iShares, BlackRock’s (NYSE: BLK) ETF unit. “Some APs will create and redeem new shares to manage their own inventory, while those who do not engage in market making simply facilitate creations and redemptions on behalf of their clients,” he says. [Meet the Market Makers: The ETF Ecosystem at Work]
Some ETFs saw their spreads widen over the summer when a computer glitch at Knight roiled trading in some stocks and triggered a $440 million loss at the firm. [Knight Debacle Raises Concern Over ETF Trading, Liquidity]
Liquidity providers and authorized participants are extremely important to the orderly functioning and trading of ETFs. [Five Lessons for ETF Investors After the Knight Meltdown]