Liquidity Provider Program
1. 2008 Liquidity Provider Program
Although Taiwan’s ETF market formally began in 2003, only a small portion of ETFs experience any significant trading value, and those that do have excessively high trading values. During periods of light liquidity, ETFs would transact at large deviations from their net asset value (NAV). In order to protect investors from the volatility that results from such a phenomenon, TWSE launched a Liquidity Provider Program in 2008 which aimed to ensure that ETF market prices aligned more closely with their underlying NAVs. The program was based on an incentive scheme that rewarded LPs for ETF trading value levels; at the same time, the scheme encouraged active market making by LPs as a means to revitalize the market. The following conditions formed the basis for trading-value-based incentive program:
- ETF issuers (SITEs) could designate up to three LPs per ETF.
- Subject to certain performance criteria, LPs could receive rebates and monetary rewards from TWSE.
2. 2014 Liquidity Provider Program
A report on the Liquidity Provider Program published in 2013 showed that while turnover rate of ETFs (202%) amounted to 2.5 times that of the turnover rate on the equity market (82.64%), Taiwan’s ETF market was still experiencing significant problems with liquidity, especially when the trading value of the top three most actively traded ETFs made up at least 80% of the entire ETF market trading value.
Taking investor concerns of liquidity and bid-ask spreads among other things into consideration, TWSE scrapped its previous Liquidity Provider Program and launched a revamped version that took effect on September 1, in tandem with the roll-out of TWSE’s new additions to its ETF product offering in the fourth quarter, namely leveraged/inverse ETFs.
The revamped Liquidity Provider Program is designed to encourage compliance with quoting obligations and offers a new incentive scheme.
- Minimum of one Liquidity Provider (Securities Firm) per designated ETF
All domestic ETF issuers (i.e. trusts), regardless of whether the ETF tracks domestic or offshore securities, have to designate at least one market maker (i.e. securities firm) for that ETF. At the same time, the previous restriction of three LPs per ETF has been eliminated in favor of encouraging dealer participation and healthy competition in the ETF market.
- Predefined quoting obligations
Minimum quoting obligations for ETFs are governed by the following conditions and principles: LPs have to provide continuous quoting at a predefined price range with a maximum bid-ask spread. Where quotes do not meet these conditions within a set time frame, punitive measures for a breach by the LP of its quoting obligations will take effect. Measures to enforce compliance with these conditions are also included in the LP agreement.
- Incentive Scheme
A monetary award is given to the top three liquidity providers for meeting predefined criteria for their designated ETFs.