January 29, 2018

Via Electronic Mail ([email protected])

Jennifer Piorko Mitchell
Office of the Corporate Secretary
FINRA
1735 K Street, NW
Washington, DC 20006-1506

Re: FINRA Retrospective Rule Review on the Effectiveness and Efficiency of Its Payments for Market Making Rule (FINRA Rule 5250); Regulatory Notice 17-41

Dear Ms. Mitchell:

The Securities Industry and Financial Markets Association (“SIFMA”)1 submits this letter to the Financial Industry Regulatory Authority (“FINRA”) to provide comments on FINRA’s retrospective rule review on Rule 5250, which limits issuers’ ability to pay market makers. SIFMA supports, and appreciates, the continued enhancement of FINRA rules through the retrospective review process. As described below, we have specific recommendations for amending Rule 5250 to allow issuers of Exchange Traded Products (“ETPs”), including Exchange Traded Funds (“ETFs”), to make direct payments to market makers. In addition, we recommend that FINRA use its retrospective rule review process to consider changes and updates to all of its rules that affect ETPs.

In response to the current request, SIFMA recommends that FINRA amend Rule 5250 to allow market makers receive payments directly from ETP issuers. Our support for allowing these payments is based on the specific nature of ETPs, which draw their market price from the market price of the ETP’s component securities. As a result, market makers would not have the incentive to use issuer payments to distort ETP prices. Disconnects between the price of an ETP and the price of its component securities are quickly corrected in the market, especially by arbitrage traders. Our views in this letter are limited to ETP issuers and do not apply to corporate issuers.

Current Rules Allow ETPs to Indirectly Pay Market Makers

FINRA Rule 5250 generally prohibits broker-dealers from accepting payments from issuers for market-making activities.2 The historic purpose of Rule 5250 has been to safeguard that market makers act independently and avoid influencing the price of the quote to its benefit. Prohibiting issuers from paying market-makers quelled a fear that public investors would not be able to ascertain which quotations in the market are based on actual market interest and which ones are supported by issuers or promoters from issuers paying market makers.3 More recently, FINRA amended Rule 5250 to allow exchanges to develop programs for ETP issuers to indirectly pay market makers to incentivize liquidity. 4 That rule change improved the ETP market by enhancing liquidity, narrowing spreads, reducing transaction costs, and creating a more efficient market; particularly for new and low-volume ETPs.

More specifically, the Securities and Exchange Commission (“SEC”) approved rule changes filed by NYSE Arca, 5 NASDAQ, 6 and CBOE7 to allow the exchange to serve as a conduit for ETP issuers to indirectly pay market makers. The SEC approved these incentive programs because the trading price of an ETP closely mirrors the market value of the securities it holds to prevent market makers being able to influence the price of the quote.8 With some variances in the specifications, NYSE Arca Equities Rule 8.800, NASDAQ Rules 5950 and 7014(f), and BATS BZX Rule 11.8, generally allow ETP issuers the option to enhance liquidity by paying an additional fee, ranging from $10,000 to $70,000, to the exchanges. As per the rules, the exchanges then use this additional revenue to pay eligible market makers rebates for posting liquidity from about $0.0033 to $0.0070 per share and $0.0001 to $0.0008 per share for certain securities if the market-maker has a designated number of ETPs assigned. To be eligible for the rebates, designated market makers must meet performance standards, set by the
exchanges, such as: percent of time at NBBO, percentage of executions better than the NBBO, average displayed size, and average quote spreads.

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1 The Securities Industry and Financial Markets Association (SIFMA) brings together the shared interests of hundreds of securities firms, banks and asset managers. SIFMA’s mission is to support a strong financial industry, investor opportunity, capital formation, job creation and economic growth, while building trust and confidence in the financial markets. SIFMA, with offices in New York and Washington, D.C., is the U.S. regional member of the Global Financial Markets Association (GFMA). For more information, visit http://www.sifma.org.

2 See Notice to Members 75-16 (February 20, 1975); Exchange Act Release No. 38812 (July 3, 1997), 62 FR 37105.

3 See Notice to Members 75-16.

4 Order Approving a Proposed Rule Change by Financial Industry Regulatory Authority, Inc. Relating to FINRA Rule 5250 (Payments for Market Making), Exchange Act Release No. 69398, 78 Fed. Reg. 24,261 (Apr. 18, 2013).

5 See Order Approving a Proposed Rule Change by NYSE Arca, Inc. To Implement a One-Year Pilot Program for Issuers of Certain Exchange-Traded Products, Exchange Act Release No. 69706, 78 Fed. Reg. 35,340 (June 6, 2013).

6 See Order Approving a Proposed Rule Change by NASDAQ Stock Market LLC To Establish the Market Quality Program, Exchange Act Release No. 69195, 78 Fed Reg. 18,393 (Mar. 20, 2013); See also Proposed Rule Change to Amend NASDAQ’s Fees Rule at 7014(f), Exchange Act Release No. 78912 (September 23, 2016).

7 See Rule Change to Institute an Incentive Program for Market Makers for BATS Exchange, Inc., Exchange Act Release No. 72020 (April 25, 2014).

8 Id.