The full interview can be found here. I previously touched on Knight's trading in the ADR sector using RWE Group as an example.
Ulam: What are some of the key challenges regarding new ETFs coming on the market in terms of establishing liquidity?
Browne: If you look at the ecosystem of ETFs, market makers historically rest at the arbitrage band. Wherever the arbitrage is located, market makers will begin quoting at that band. And the further you go through this band, the more liquidity shows up. That’s fundamental. There’s no disagreement about that.
But what’s missing with new ETFs is that you have the market makers quoting inside the arbitrage band; what’s missing is the retail flow inside the arbitrage band, keeping the appearance that ETFs are liquid and tight.On making markets in esoteric or multi-currency securities:
Ulam: So what are some of the challenging asset classes for pricing?
Browne: Fixed income, no doubt. Commodities, for example, also get challenging because of the way that they are structured.
The complexities of the underlying assets are not well understood by all market makers. Let’s say you wanted to trade Asian equities. In many of those markets, you have a transaction tax. And you have boundaries around liquidity of foreign exchange. So if you’re trying to move a large notational trade, you have different components of liquidity.
You have the liquidity of underlying equities that the ETFs are associated with and you have FX liquidity—not everyone takes that into consideration.
Ulam: So that could be challenging for some of these emerging market ETFs?
Browne: Emerging market ETFs, fixed income, commodities—they all have these characteristics. I have customers all the time saying I won’t pay more than a penny over the quoted offer in the markets for any notional size. And it’s such a misnomer because you have liquidity or impact restraints.
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