Nasdaq OMX Group less than a month ago announced plans to re-launch its PSX exchange as a "better trading venue" for exchange-traded funds, notes and other related products.
An ETF-focused national exchange.
So? Why should any fund operator want to push any trading of shares in its products toward the upstart?
So far, Nasdaq has not yet detailed how it plans to take a big chunk of trading volume away from other exchanges.
In theory, PSX intends to be a head-to-head competitor with NYSE Arca, which is home to 93% of all listed exchange-traded funds.
Not that surprising, since the all-electronic Arca exchange took over the American Stock Exchange's ETF business after both markets were acquired by the New York Stock Exchange. The American exchange-now renamed NYSE MKT-is the market that, in effect, was the birthplace of the exchange-traded fund industry.
In 1993, the Amex worked with the State Street Corporation to come up with something called the SPDR S&P 500 ETF Trust (SPY). That was the first exchange-traded fund, whose components match the Standard & Poor's 500, and whose shares can be traded at any time on a national stock exchange.
The Amex was the incubator of the ETF business through roughly 2003, notes Timothy Coyne, global head of ETF Capital Markets at State Street Global Advisors.
Today, roughly $1.4 trillion in assets are held in exchanged-traded funds in markets in the United States. And NYSE Arca carried out 21.5% of trading in March.
But that doesn't make it the biggest source of trading. Roughly 33% of all activity in ETF shares takes place in the dark: anonymous trading in broker and other off-exchange pools of orders.
And despite its overwhelming dominance of listings, NYSE Arca does not dominate trading, even on so-called "lit" exchanges where prices are displayed every time a trade is made.
Out of 1,442 exchange-traded notes, funds or other such products now on publicly traded markets, 1,328 are listed on NYSE Arca. Less than a hundred-96 -are listed on the Nasdaq Stock Market. And 18 on the upstart BATS Exchange.
Yet, Nasdaq, with far fewer listings, handles 13.7% of all ETF trading, its BX exchange another 2.8% and its PSX exchange another 1.6%.
BATS handles 14.6% through its two exchanges. And Direct Edge, which does not list any ETFs on its own, handles 11.0%.
Now the exchanges are starting to joust with each other through different forms of "market quality" programs. In one fashion or another, the exchanges are starting to compensate firms for making markets in exchange-traded funds.
The first out of the box was BATS Global Markets, with its Competitive Liquidity Provider program.
That program incents market-making firms to provide a continuing stream of quotes on exchange-traded products that are "inside" the best bid or offer on any venue where shares are traded.
If, as BATS chief operating officer Chris Isaacson describes it, the market-maker who provides the best flow of quotes-in price and size-to buy or sell shares in a given security in a given day will get 80% of the reward, say $200 a day. The second place "winner" gets the other 20%. Finish atop the leaderboard consistently over time and over multiple ETFs and you're talking real money.
The Securities and Exchange Commission has approved a different plan from Nasdaq OMX Group. In its approach, a fund's sponsor pays $50,000 or $100,000 a year to be part of the program. And Nasdaq deals out payments to market makers, in proportion to how actively they make a market in that fund.
NYSE Arca is seeking approval for its own program, as well.
In March, BATS also started publishing what it called "market quality" statistics, drawn from standardized data on the consolidated tape of stock and exchange-traded fund transactions.
The highest rankings go to the exchange that gets the best prices for both sellers and buyers. In effect, "execution quality" equates to generating the narrowest spreads between offers and bids. For 60 out of the top 100 exchange-traded products, for instance, BATS Global Markets' primary exchange, the Z exchange, achieved the narrowest spreads on April 2.
NYSE Arca says it stays ahead of rivals by its "consultative" approach with new issues of ETFs, helping them find everything from an index creator to a custodian to a transfer agent, in order to get started.
If it doesn't have an index in its quiver, then, it will create one, says Laura Morrison, senior vice president for global indices and exchange-traded products of NYSE Euronext.
Nasdaq, in effect, is raising that ante. By the end of the year, it plans to launch and maintain 150,000 indices, in competition with major index providers such as Standard & Poor's, Russell Investments and MSCI. And it is prepared to create custom indices for ETF issuers, along the way.
But even with exchanges avidly vying for new listings, through the incentive programs and the statistical comparisons on spreads achieved, State Street Global Advisors is standing pat. It requests and gets reports each month from the exchanges on how well each is performing on narrowing the spread on shares traded in its funds, how deep the book of orders is and what the typical size of an order is, at both the bidding price and the offer price.
To date, it has kept all its listings on NYSE Arca. This includes both the S&P 500 product, known as SPY, that is the most widely traded ETF. And GLD, the third-most widely traded ETF, which is a proxy for trading in gold.
But Coyne says that could change. As the incentive programs get launched, State Street will watch whether assets grow in any particular funds under any particular market-making program and react accordingly.