In an attempt to boost liquidity in the event of another market “flash crash,” stock exchanges are engineering incentive programs to ensure market makers are there for exchange traded funds, according to a recent report.

In the NYSE’s pilot program, ETF issuers will pay financial firms to set a retainer to act as lead market-makers for their funds. Fund issuers can opt to pay between $10,000 and $40,000 per exchange traded product annually so that lead market makers, or LMMs, can receive fixed quarterly fixed payments, instead of variable enhanced transaction rates, for hitting monthly LMM quoting obligations. [NYSE Implements Market-Maker Incentive Program to Augment ETF Liquidity]

“Machines [used by market-makers]are programmed to pull away when things are not perfect,” Eric Hunsader, founder of trade research firm Nanex, said in a Financial Times article. “The degree of disruption during the flash crash affected more market-making systems than normal but events like that happen daily – just to a less severe level.”

Some have argued that ETFs are more susceptible to volatility since they rely on market makers to ensure trades on an ETF’s underlying stocks and Authorized Participants to keep ETFs from deviating from their underlying assets.

APs help the funds reflect the price movements of the underlying index by arbitraging small differences between the ETF’s share price and the underlying shares through creations or redemptions of ETF shares.

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