An authorised participant (AP) is a financial institution that manages the creation and redemption of ETF shares in the primary market. Each AP has an agreement with an ETF sponsor that gives it the right (but not the obligation) to create and redeem ETF shares. APs may act on their own, or on behalf of market participants. Market makers are broker-dealers that regularly provide two-sided (buy and sell) quotes to clients. In some instances, an ETF’s market makers may also be APs. APs and market makers operate in a highly competitive environment and are economically incentivised to take part in making or trading ETF shares.
Historically, if an AP has withdrawn from the ETF market, other APs have stepped in to facilitate the creation and redemption of ETF shares, particularly if there was a significant premium or discount to its net asset value (NAV), or difference between the price of the ETF and its underlying holdings. This is because APs generally seek to take advantage of economic arbitrage opportunities arising from that difference (for example, if an ETF is trading at a price above its NAV, an AP could buy the underlying securities and exchange them with the ETF issuer for newly created ETF shares, which may then be sold in the market for a profit).
That same incentive holds true for market makers as well. A market maker regularly provides two-sided (buy and sell) quotes to clients on the exchange. Market makers are key liquidity providers in the ETF ecosystem that ensure continuous and efficient ETF trading in the secondary market.
The role of a market maker is distinct from the role of an AP, though both are necessary for robust ETF trading activity. A market maker does not need to be an AP, nor does an AP need to be a market maker. Still, some firms play both roles in certain ETFs. Ultimately it is this “arbitrage mechanism” that helps keep the ETF’s market price close to the value of its underlying holdings each day.
In Australia, each listed ETF is required to have a designated market maker, this market maker has set obligations to provide a minimum quantity at a spread up to a defined maximum schedule for at least 80% of the time during market hours. These obligations are set out in a contract with the ETF issuers.
iShares have multiple market makers on all ETFs including but not limited to the designated market maker.
Examples of market makers include JP Morgan, BNP Paribas, Susquehanna, Jane Street and Nine Mile Financial.