Debunking Collusion Claims in ETF Market Making: An Insider’s Perspective

Domestic ETFs: Consistency in Calculations

For domestic ETFs, market makers focus on maintaining tight spreads and accurate pricing by relying on well-established methodologies. Challenges such as corporate actions—like stock splits or dividend adjustments—and ensuring the correct basket composition during rebalancing can arise, but these issues rarely cause significant divergence in fair value calculations among market makers. The reality is that most market makers arrive at similar valuations because they use shared data sources and apply proven methodologies.

Foreign ETFs: Beta and Correlation Adjustments

When it comes to foreign ETFs, the pricing process involves additional complexities but is grounded in similar principles. Market makers adjust their valuations based on betas, correlations to futures, and other global indicators. While these factors can introduce slight divergences, most practitioners rely on common benchmarks and data points, leading to broadly aligned fair values across the ecosystem.

Fixed Income ETFs: Transparency Through Market Data

Fixed income ETFs operate on comparable principles but require specialized data inputs. Market makers assess fair value by examining where bonds traded in previous days on platforms like MarketAxess or by referencing marks from IDC or Bloomberg.

They also consider the pricing of similar ETFs, ensuring that their valuations reflect market realities. This systematic approach further underscores the shared methodologies used across the industry.

The Creation and Redemption Process: Ensuring Fair Value

The creation and redemption process plays a critical role in keeping ETFs close to the fair value of their underlying components. By constantly promoting arbitrage opportunities that arise with volatility and order flow, this mechanism ensures pricing efficiency.

While firms may differ in how they manage the equity used in this process, higher interest rates incentivize them to avoid inefficiencies, such as holding large, hedged positions that do not generate returns.

Additionally, market makers may face varying commission rates and other variable costs depending on their partners, but competition narrows these disparities, preventing significant divergences.

A Shared Ecosystem

The ETF market-making ecosystem is relatively small, with many participants sharing similar training and methodologies. A substantial number of today’s market makers began their careers on the AMEX and NYSE floors or at firms like SIG and Goldman-SLK.

This shared history explains why pricing techniques are aligned—it’s a product of collective expertise, not collusion. As ETF.com notes, “The market makers hardly touch each other’s ETF positions. But they nearly always go for the ETF flows from retail investors.”¹

While this observation could be interpreted negatively, it is more likely a reflection of strategic behavior and respect for each other's calculations rather than evidence of coordinated action.

Professional Hesitancy and Mutual Respect Among Market Makers

Beyond shared methodologies, another factor contributing to this dynamic is a level of professional hesitancy between market makers when their fair value calculations differ. Instead of trading aggressively with one another, market makers often respect the opposing trader’s calculations and may question their own values before engaging.

This behavior reflects a broader culture of mutual respect within the ecosystem, where trading decisions are guided by carefully derived valuations and risk management considerations.

Rather than indicating collusion, this hesitancy illustrates the trust and discipline that experienced market makers bring to ETF liquidity provision.

Public Data and the Importance of Transparency

The data underpinning ETF pricing—whether from Bloomberg, Reuters, or MarketAxess—is publicly available and widely shared. The only unknowns arise when large orders are executed through RFQ (Request for Quote) platforms.

Payment for order flow can result in some firms gaining access to information that others do not, creating potential disparities. To promote fairness and competition, it is crucial to ensure that all orders are routed to exchanges.

This would enhance transparency, foster market maker diversification, and eliminate advantages tied to larger budgets.

The Real Narrative: A Unified Approach

Rather than collusion, the alignment observed in ETF market making reflects a unified approach built on shared data, proven methodologies, and decades of collective expertise.

By focusing on transparency and fair access to information, the industry can continue to thrive while addressing misconceptions about its operations.

“The activity of ETF market makers on Euronext Amsterdam is consistent with collusion,” said Alvaro Cartea, Professor of Mathematical Finance and Director of the Oxford-Man Institute of Quantitative Finance.²

While this statement may raise eyebrows, it’s worth noting that the observed behaviors likely stem from shared methodologies and common practices rather than explicit coordination. It’s also important to remember that with over 4,000 ETFs in the U.S., market makers may not always display significant liquidity on screens for risk management purposes.

Historical incidents, such as the programming error that caused significant losses for Knight Capital Group, highlight why market makers tend to avoid putting excessive live orders on display, especially in volatile products.³

The accusations of collusion warrant scrutiny, but they also present an opportunity to educate stakeholders about the intricacies of ETF market making. By fostering a better understanding of these dynamics, we can ensure a more informed and equitable marketplace.

About the Author

Nicholas Phillips | President of ETF Capital Markets Advisors LLC
With over 25 years of experience in ETF market making and capital markets, Nicholas Phillips is recognized as a subject matter expert in the ETF industry. He started his career spending the first ten years as a lead market maker for SIG and Goldman Sachs.

At the helm of MCAP LLC's ETF Desk, Nicholas built and scaled the division, enhancing its operations through innovative pricing and risk models, and robust relationships with market makers and issuers. His tenure at Van Eck Associates as Director of ETF Capital Markets further solidified his expertise, managing critical facets of operations and deepening connections within the trading community.

Beyond market making, Nicholas is an avid content creator, sharing insights that demystify complex market dynamics. He is keen on exploring board member roles that benefit from his extensive background and forward-thinking approach to ETF strategies. His dual US/Ireland citizenship complements his global perspective, enriching his professional endeavors in diverse markets.

References

¹ETF.com, “Study: Market 'Collusion' in ETF Trades on Euro Exchange,” January 23, 2025.

²Source: University of Oxford, “Anonymity, Signaling, and Collusion in Limit Order Books.”

³U.S. Securities and Exchange Commission, “Knight Capital Group Case Study.”

Disclaimer

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.