ETF trading volume exceeded $1.4 trillion in 2025, with market makers handling more than 99% of secondary market transactions. Yet many asset managers don’t fully understand how ETF market making works, or how to use it for better liquidity and pricing.

This guide explains the mechanics of ETF market making, from compensation models and stress scenarios to evaluation criteria and performance KPIs, giving asset managers the knowledge they need to build stronger market maker partnerships.

What is ETF market making?

ETF market making is the practice of providing liquidity in the secondary market to support accurate, daily trades between brokers and individual ETF investors. 

Market makers, sometimes called broker-dealers, are a critical part of the secondary market. Their ability to provide continuous trading boosts liquidity and helps asset managers determine pricing.

Core functions of market makers

Where authorized participants create and redeem shares on the primary market, it is market makers who match buyers and sellers on the secondary market. 

Their core functions include:

• They provide bids and asks (two-sided quotes) to other market participants to keep the value of the ETF in line with Net Asset Value (NAV) on an intraday basis during the trading day.
• Market makers buy and sell ETF shares, ensuring that there is an inventory of shares to allow for easy transactions between buyers and sellers.
• They facilitate price discovery by continuously updating quotes based on real-time market conditions.
• They assume inventory risk to ensure continuous liquidity throughout trading hours.

Understanding these functions helps asset managers evaluate whether market makers are fulfilling their fundamental obligations. It also helps them identify any service gaps that might require additional market maker partnerships.

Types of market makers

There are several different kinds of market makers, and asset managers need to understand the distinction between them, as they offer varying levels of commitment, performance standards, and support. Support is particularly critical during periods of market stress.

The basic types of market makers include:

• Designated Market Makers (DMMs): A relatively new kind of market maker. Previously called “specialists,” DMMs were introduced by the New York Stock Exchange in 2008 to increase competitiveness and market quality. The creation of this role happened in tandem with the growing dominance of electronic trading. They are market makers who have been selected by an exchange, such as NYSE, to enhance and maintain a set list of securities.
• Lead Market Makers (LMMs): These market makers have an elevated status that comes with greater responsibilities. Like all market makers, they help optimize liquidity and make price discovery more transparent. They have a mandate to demonstrably enhance market quality in the form of tighter markets.
• Supplemental Liquidity Makers (SLPs): Market participants that create high volume on exchanges with the goal of keeping markets liquid. Exchanges will offer them rebates and incentives for providing enhanced liquidity. SLPs date back to the early stages of the Great Recession.
• Standard Market Makers: These are regular market makers with no special designations.

When building your market maker roster, consider including a mix of these types to balance commitment levels, with at least one LMM or DMM to ensure enhanced support during periods of market volatility.

You might like: A closer look at authorized participants in the ETF ecosystem

How market makers support ETF liquidity and pricing efficiency

Market makers support ETF liquidity through three major mechanisms: liquidity provision, price discovery, and maintaining pricing efficiency during stress.

Liquidity provision

1. As liquidity providers, market makers provide constant bid-ask quotes with narrowing bid-ask spreads to encourage trading, resulting in higher liquidity and lower transaction costs for individual investors.
2. Market makers assume the risk of holding ETF shares to facilitate easy trades. 
3. During periods of volatile market conditions, market makers maintain quote obligations, with regulatory exceptions for extreme events such as circuit breakers or market halts.

Asset managers should monitor bid-ask spreads and quote consistency to track whether their market makers are adequately fulfilling these responsibilities.

Price discovery and pricing efficiency

To keep ETF share prices efficient and accurate, market makers balance supply and demand. They are consistently quoting up-to-date bid-ask spreads. Additionally, market makers ensure that market prices stay in line with NAV and act to prevent large deviations in price.

Providing accurate pricing and liquidity in the secondary market works hand-in-hand with price discovery. This ensures real-time valuation of intrinsic fair value throughout the trading day.

Compensation models

Understanding how market makers function economically is essential for asset managers. Truly knowing their economic landscape can help asset managers negotiate better relationships and understand how a market maker will operate when markets are stressed. It is critical to understand the structuring agreements that benefit all parties involved.

Here’s how market makers earn compensation:

• Bid-ask spread: The primary profit for market makers comes from buying at bid and selling at ask.
• Exchange rebates: Given their importance, market makers receive payments from exchanges for the service of providing liquidity and assuming risk.
• Payment for order flow: Sometimes, market makers will receive compensation from brokers routing orders to them.
• Market share incentives: Some exchanges have programs that reward high-volume market makers, creating additional incentives.

Knowing these revenue streams allows asset managers to structure agreements that bring ETF performance goals into alignment with market maker incentives, allowing both parties to benefit.

Market stress scenarios and limitations

Despite these revenue opportunities, market makers often face challenges during periods of market stress, which can impact their ability to provide consistent quotes and tight spreads.

Examples of scenarios that can strain market maker operations include:

• Flash crash events: Extreme volatility can trigger risk management protocols that cause market makers to step back from their quote obligations temporarily, widening spreads dramatically until market conditions stabilize.
• Circuit breaker periods: When exchanges halt trading, market makers cannot maintain continuous quotes, creating gaps in liquidity that can affect price discovery when trading resumes.
• Illiquid underlying securities: Market makers widen spreads significantly when the ETF’s underlying assets become difficult to hedge, particularly in emerging markets, international, fixed income, commodity, or derivative-based ETFs where the underlying markets may be closed or experiencing their own liquidity constraints.
• Capital constraints: Regulatory capital requirements can limit how much inventory market makers can hold, especially during volatile periods when risk-weighted assets spike, potentially reducing their ability to provide depth at quoted prices.

Partnering with an index provider like VettaFi can help mitigate these challenges. VettaFi’s expertise in market structure ensures that ETFs are designed with features that make it easier for market makers to provide consistent liquidity even during stressed market conditions.

How market makers facilitate ETF trading activity

Liquidity is essential to the success of any product. Strong liquidity and accurate pricing encourages investors to invest. Market makers have incentive to trade when the ETF price doesn’t align with the price of the underlying assets.

Enabling continuous trading

Market makers facilitate daily ETF trades in critical ways:

• Constantly posting bid-ask prices: Market makers continuously update and display two-sided quotes throughout the trading day, providing real-time price signals to the market. This constant presence increases pricing efficiency and encourages trading activity by giving investors confidence they can execute at transparent, competitive prices.
• Making sure investors can always trade throughout their trading day: Market makers maintain active quotes during all market hours, preventing liquidity gaps that could frustrate investors or force them to wait for execution. Consistent availability is particularly important for asset managers marketing their ETFs as liquid investment vehicles.
• Holding their own ETF inventory to fulfill trades: Market makers hold their own inventory of ETF shares, allowing them to immediately buy from sellers or sell to buyers without delay. This inventory commitment means they're taking on market risk, which is why their compensation models include mechanisms to offset this exposure.
• Handling different order types: Market makers process various order types including market orders, limit orders, and stop orders, giving investors flexibility in how they execute trades. This capability allows both retail and institutional investors to implement diverse trading strategies suited to their specific needs.
• Promoting pre-market and after-hours trading: Where applicable, market makers extend their quoting activity beyond standard exchange hours, enabling investors to react to news and events that occur outside regular trading sessions. This is particularly beneficial for ETFs tracking international markets or responding to after-hours developments.
• Facilitating block trades for institutional investors: Market makers work directly with institutional investors to execute large orders that might otherwise move the market if traded on the open exchange. By negotiating block trades privately, market makers help institutions minimize price slippage and execution costs.

When your market maker delivers on all these fronts, it helps you create a trading experience that attracts and retains both retail and institutional investors for stronger asset growth.

Impacting different investor types

Market makers matter to all investor types:

• Retail investors benefit from tight spreads and immediate execution on smaller orders. These advantages let retail investors operate strategically in the market.
• Institutional investors require deeper liquidity for larger block trades. Market makers often work closely with institutions to minimize market impact and ensure a smooth trading experience with minimal volatility and stress.

Asset managers should care about this because these dynamics help you communicate your ETF’s tradability advantages over mutual funds to different investor segments. You can tailor your market accordingly, ensuring that both retail and institutional investors have access to your products and a smooth trading process.

Related: ETF vs mutual fund: 9 strategic considerations for asset managers

The market maker and authorized participant relationship

Market makers and authorized participants serve distinct but complementary roles in the ETF ecosystem. While some firms operate as both, it’s important to understand how they function separately.

• Market makers provide liquidity in the secondary market, but rely on authorized participants to handle the creation and redemption processes for ETF shares in the primary market.
• Both market makers and authorized participants are essential in supporting liquidity and pricing.
• When there are price differences between the ETF cost and value of its underlying securities, market makers can rely on authorized participants to create or redeem ETF shares.

Both take advantage of arbitrage opportunities

Market makers and authorized participants both leverage pricing discrepancies to keep ETF prices aligned with NAV:

• When an ETF is at a premium, market makers rely on authorized participants to create new shares. New shares increase the supply on the open market and push the price down toward NAV.
• When an ETF is at a discount, market makers buy shares on the market, which decreases supply and pushes up the market price toward NAV.

Together, these arbitrage mechanisms help to maintain efficient markets and protect investors from overpaying or underselling their ETF positions.

When firms play both roles

When a single firm operates as both market maker and authorized participant, certain dynamics emerge:

• Integrated operations: Firms acting in both roles can coordinate more efficiently.
• Potential conflicts: Potential conflicts are reduced when asset managers understand how to manage these relationships.
• Regulatory oversight: The SEC monitors for conflicts between market makers and authorized participant activities.
• Communication protocols: Firms operating in dual roles typically establish clear procedures for managing potential conflicts and coordinating between functions.

Asset managers should proactively ask dual-role firms about their conflict management procedures and request regular reporting on how they’re maintaining appropriate separation between functions.

What to consider when working with market makers

Asset managers should always examine these key criteria when choosing market makers for their ETFs:

• Track record with similar ETFs: Request performance data from comparable products.
• Technology capabilities: Assess the market maker’s algorithmic trading systems and technological infrastructure.
• Financial stability: Review balance sheet strength and regulatory capital.
• Geographic reach: Ensure the market maker has the ability to cover across relevant trading venues and time zones.
• Commitment level: Distinguish between LMM commitments and more standard market maker participation.
• Underlying asset expertise: It is one thing to have a track record with a similar ETF, but it is particularly important for a market maker to understand the underlying asset classes. This is especially true in the case of international, fixed income, or commodity ETFs.
• Market share and reputation: Consider how a market maker stands among their peers.

Use these criteria to evaluate potential market maker partnerships, weighing each factor based on your ETF’s specific needs and investor base.

Market maker agreements

Asset managers working with market makers should negotiate the following agreement terms:

• Performance commitments: Spread targets, minimum quote sizes, uptime percentages.
• Incentive structures: Payment terms, performance bonuses, exchange rebate sharing.
• Termination clauses: Notice periods, performance-based termination rights.
• Confidentiality provisions: Protection of portfolio composition and trading strategies.
• Reporting requirements: Frequency and format of performance reports.
• Technology and data access: What information market makers need and how it is shared. It is worth noting the LMM agreements typically include enhanced commitments in exchange for preferential treatment or compensation.

Review these agreement terms every year. Be prepared to renegotiate if market conditions change or if your ETF’s trading profile significantly evolves.

Regulatory considerations

There are a host of regulatory considerations to keep in mind regarding market makers. 

SEC Regulation NMS includes best execution requirements.  FINRA and exchange-specific rules also impact market makers. There are also exchange-specific rules that could impact market makers. The NYSE, Nasdaq, and CBOE operate in a distinct fashion and could have different requirements for market makers to fulfil.

Market manipulation concerns are still real. Wash trading, layering, spoofing, and prohibitions are all worth keeping an eye on. Market makers also have disclosure obligations, such as Form N-1A and prospectus requirements around liquidity.

Finally, asset manager responsibilities include overseeing market maker compliance, maintaining documentation, and reporting material issues to board and regulators.

Check out: The asset manager’s guide to SEC rule 6c-11 compliance

Tracking performance

Asset managers should establish regular monitoring protocols to evaluate market maker performance and identify potential issues before they impact investor experience. Tracking these key performance indicators provides objective data for relationship management and helps justify decisions to add, remove, or adjust market maker partnerships.

Essential metrics to monitor include:

• Average bid-ask spreads: Compare your ETF's spreads to peer products with similar strategies and track trends over time. Consistently wider spreads than competitors may indicate underperformance or inadequate market maker support.
• Quote uptime percentage: Monitor how frequently market makers maintain active quotes during market hours, targeting 95%+ uptime. Frequent quote withdrawals can signal operational issues or inadequate commitment.
• Market share of volume: Identify which market makers are most active in your ETF to understand where liquidity actually comes from versus contractual commitments. Declining share from a lead market maker warrants investigation.
• Execution quality metrics: Review price improvement statistics and effective spreads to assess whether investors are receiving better execution than posted quotes, indicating healthy competition among market makers.
• Response time to inquiries: Measure how quickly market makers respond to questions about unusual trading activity, spread widening, or operational issues. Slow response times often precede larger problems.
• Premium/discount patterns: Track how closely your ETF trades to its NAV throughout the day. Persistent premiums or discounts indicate market makers aren't effectively arbitraging price discrepancies, which is a core function they should perform consistently.

Make sure you have a quarterly review process to assess these key performance indicators (KPIs). If you have an underperforming market maker, schedule a meeting with them to address the issue before it escalates.

Warning signs of market maker issues

Not every market maker partnership will be the right fit. Here are some red flags to keep an eye out for:

• Widening spreads: There are times when spreads widen of their own accord, but keep an eye out if your product is diverging from peer ETFs.
• Inconsistent quoting: Gaps in bid-ask can indicate an issue.
• Decline in market share: If a market maker is handling a decreasing percentage of overall volume, that warrants close monitoring or investigation.
• Operation errors: Settlement failures and pricing mistakes should be minimal.
• Reduced responsiveness: Slow or inadequate communication could be a sign of problems.
• Financial instability: Regulatory actions and credit downgrades are red flags.
• Persistent premiums and discounts: Failure to maintain NAV alignment is a failure of the basic job of being a market maker.

If you observe several warning signs at once, contact the market maker immediately and start looking at backup options to protect your ETF’s liquidity profile.

ETF market making FAQs

What’s the difference between a lead market maker and a regular market maker?

A lead market maker (LMM) has enhanced obligations and privileges on an exchange, including tighter quoting requirements and more presence in the market. Regular or “standard” market makers provide liquidity but without the heightened commitments. LMMs often receive benefits like lower fees or rebates in exchange for their elevated role.

How many market makers should an ETF have?

An ETF needs at least one market maker to operate, but most have three to four market makers. Large ETFs often have 10 or more competing to provide liquidity, usually resulting in tighter spreads or better pricing.

Do market makers charge fees to ETF issuers?

No, market makers typically do not charge fees to ETF issuers. They earn revenue through bid-ask spreads and may receive rebates or reduced transaction fees from exchanges for providing liquidity to the ETF.

What’s a good bid-ask spread for an ETF?

Tighter spreads are generally better, but a good big-ask spread tends to vary by asset class and product type. Ideally, the spread to aim for is the tightest spread possible in the current market environment for the particular security.

Can an ETF function without market makers?

No, ETFs cannot function effectively without market makers. Market markers are essential for providing continuous liquidity, facilitating the creation and redemption process, and ensuring investors can buy and sell shares throughout the trading day at fair prices.

How do I know if my ETF has good market maker support?

Good market maker support is indicated by consistently tight bid-ask spreads (close to the asset class average), high trading volume, minimal price deviation from net asset value (NAV), and stable liquidity even when the market is volatile.

Optimizing your ETF market making strategy

Market makers are essential partners in ETF success, providing the liquidity and pricing efficiency that attracts investor capital. By understanding market makers’ compensation models, stress limitations, performance metrics, and other operational functions, asset managers can build stronger partnerships and negotiate better agreements to ensure their ETFs deliver consistent tradability.

Whether you’re launching a new ETF or optimizing an existing one, strategic market maker relationships supported by thoughtful index design can make the difference between a product that merely functions and one that thrives.