ETFs are made of a basket of underlying securities. If an ETF shows a premium or discount to its NAV, market makers help keep the market value of an ETF in line with the fund’s underlying basket of securities. If an underlying component experience a change, then the ETF market maker would have to cancel existing offers to buy or sell and replace them with new orders to reflect the sudden change in the component.
Market observers argue that with Clinton focusing on cancellations, a tax on the normal process could hinder an important function of market makers – market makers would typically execute a simultaneous buy and sell order to arbitrage or capitalize on the small difference between prices throughout the day.
“If it’s a small fee used for regulatory purposes, then it could be helpful. If it’s more than that, it could end up costing investors more money in a lot of ways,” James Angel, a professor at Georgetown University who studies markets, told the WSJ.
Consequently, to accommodate a potential new tax on trading, a market maker may be forced to widen spreads to accommodate the added costs, which would only “end up costing investors more,” Bill Harts, spokesman for the high-frequency trading group Modern Markets Initiative, said.
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Max Chen contributed to this article.