The Foundations of ETF Liquidity Part III: Building the Right Partnerships for a Successful ETF Launch

The Role of Lead Market Makers (LMMs)

Selecting the right Lead Market Maker (LMM) is one of the most critical decisions an issuer makes when launching an ETF. The LMM acts as the primary liquidity provider, responsible for quoting prices and maintaining tight spreads, especially during periods of low trading activity. But not all LMMs are created equal, and understanding their strengths and objectives is vital for building a partnership that benefits your fund and its investors.

Understanding LMM Priorities

LMMs vary in their approach. Some prioritize speed, excelling in high-frequency trading environments. Others specialize in specific asset classes like fixed income, options, or commodities. Understanding these nuances helps issuers align their needs with the LMM’s expertise.

• Does the LMM have experience in your asset class or strategy?
• Are they equipped to handle the complexities of your ETF’s structure?

Evaluating the LMM Relationship

Issuers should seek an LMM that is looking to build a lasting partnership. This means engaging in open conversations about expectations and ensuring both sides understand what it takes to make the ETF a success.

• Does the LMM have the bandwidth and interest to support your product long term?
• Are they aligned with your vision, or are they seeking a short-term revenue opportunity?

Collaborating for Success
Success depends on communication and shared goals. Issuers should clearly articulate their expectations for liquidity and spread performance while being receptive to the LMM’s needs, such as consistent trade volumes or transparency in basket composition.

The Strategic Importance of Authorized Participants (APs)

While LMMs are the public face of ETF liquidity, Authorized Participants (APs) are the backbone of the creation and redemption process. They enable ETFs to expand and contract efficiently, maintaining their alignment with the underlying asset value. Partnering with the right APs ensures your ETF can scale as demand grows.

AP Expertise and Alignment

Like LMMs, APs have specialties. Some cater to fixed income ETFs, while others excel in equities or alternative strategies. Knowing which APs align with your product is critical.

• Are the APs you’re considering equipped to handle your ETF’s unique asset class?
• Do they have the operational infrastructure to manage high-demand periods?

Balancing the AP Roster

While having a single AP can suffice for niche products, most ETFs benefit from multiple APs. This diversification reduces dependency on any one partner and ensures resilience during market stress.

• How many APs do you need to support your ETF effectively?
• Are there risks of concentration in your current AP relationships?

AP and LMM Interdependence

The relationship between LMMs and APs is crucial. Some APs have preferred LMMs they work with, and aligning these relationships can enhance your ETF’s liquidity profile. Understanding these dynamics allows you to choose partners who complement each other, ensuring seamless operations.

Building Long-Term Partnerships

Launching an ETF isn’t just about getting it to market; it’s about ensuring its success over time. This requires building relationships with LMMs and APs who share your commitment to the product’s growth and who can adapt to changing market conditions.

Partner for the Long Haul

Look for partners who prioritize collaboration and transparency. A good LMM or AP will invest time in understanding your product, offering insights to improve its structure and performance.

• Does your LMM or AP see your product as part of their long-term strategy?
• Are they willing to adapt and innovate as the market evolves?

Ongoing Communication
Regular touchpoints with your LMM and AP partners ensure that any issues can be addressed promptly. This ongoing dialogue also allows you to refine your ETF’s strategy as it matures.

Conclusion: The Value of Experience

Launching a successful ETF is as much about relationships as it is about strategy. By carefully selecting LMMs and APs who align with your goals and asset class, you set the stage for lasting success. Years of knowledge and expertise in capital markets are invaluable in making these decisions—partnering with firms that understand the intricacies of ETF trading ensures your product can grow and thrive in a competitive market.

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.

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.