(This is the first in a two-part series on the role of designated market makers at the NYSE)
To work properly, an exchange market must continually offer the opportunity to buy and sell in an orderly fashion. Much of a New York Stock Exchange designated market maker’s work is directed to ensuring that such a market exists: while the designated market maker makes a market throughout the day, the market maker is ready to trade when no one else will, and they act to stabilize the market in the issues in which they are designated market makers. Thereby it is the market maker’s liquidity that sustains a continuous market in the shares of a symbol. In the past market makers were known as specialists. Some folks still use the word specialist interchangeably with designated market maker, including me. Each stock is assigned to one of these designated market makers on the NYSE floor.
According to the NYSE, they are selected by a listing issuer in one of two ways:
“Option 1: Issuer selects an eligible designated market maker.
Option 2: Issuer delegates authority to the exchange to select an eligible designated market maker.
The exchange requires that the market maker maintain a service relationship with officers of the corporations in whose securities they specialize. This relationship allows the listed company to understand the market dynamics of the trading in their stock. However, neither the market maker nor their associates (including clerks) may serve as officers or directors of those corporations. They are also not permitted to participate in proxy contests in the firms in whose stocks they are the designated market maker. Finally, they are under strict rules pertaining to non-public information.
Designated market maker trading is proprietary trading and the those firms must meet stringent capital requirements to enter and maintain the business. The vast majority of the market maker’s trading is “liquidity adding” meaning that they buy on the bid and sell on the offer. This by its very nature provides a dampening effect to the volatility of a stock’s trading. The NYSE sets multiple performance standards that the market maker must meet on a daily basis. The objective of these standards are to provide investors the National Best Bid and the National Best Offer when they trade on the NYSE. Additionally, the designated market maker must quote at price points outside of the immediate market place or must quote when no other market participants are willing to do so thus creating broad stability in the market for a stock.
Again according to the NYE, “The cornerstone of the NYSE market model is the Designated Market Maker or DMM. Formerly known as ‘Specialists,’ DMMs are the only participant to have true obligations for maintaining fair and orderly markets for their assigned securities. 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 crucial for improving prices, dampening volatility, adding liquidity and enhancing value. DMMs apply keen judgment to knowledge of dynamic trading systems, macroeconomic news and industry specific intelligence, to make their trading decisions.”
Check in next week for more on specialists and their role as market markets.
Quote of the week: “Criticism is a disinterested endeavor to learn and propagate the best that is known and thought in the world” — Matthew Arnold
Bart Ward is the chief executive officer of Ward & Co. Ltd., an Anoka-based registered investment adviser – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.