Everything Old Is New Again—Maybe

In the past few weeks, Bats Exchange and Direct Edge have been putting pieces in place to introduce market-makers into their exchanges. The question is whether these programs will succeed in a post-Regulation NMS world after the Securities and Exchange Commission (SEC) eliminated the use of stub quotes and other practices on which market-makers once relied.

Both programs are in nascent stages. Bats Exchange filed its notice with the SEC in mid-December 2011 and Direct Edge notified clients that it had put the mechanics in place for firms to operate as market-makers. Neither has gone as far as to provide public details on planned rebate schedules.

The two programs appear to have different goals. Bats Exchange looks to use its Competitive Liquidity Provider (CLP) program as a limited liquidity incubator for the newly listed instruments. Traders will not see CLP-based rebates on liquid issues like IBM or Microsoft. Direct Edge, meanwhile, is looking to offer market-making capabilities to qualified members across the symbols traded on its exchanges.

It will be interesting to see exactly how large a rebate each exchange operator will need to offer to induce members to participate in their programs—too small, and they won’t counter-balance the level of risk firms assume as market-makers or CLP participants; too high, and the exchange operators will see these programs cutting into their profitability.