ROLE OF MARKET MAKER IN STOCK MARKET

INTRODUCTION

Securities market always engages the attention of not only of the government but the general public as well. The Securities market is flooded with so many participants such as brokers, members, merchant bankers, and the general public, of course. Involvements of such large participants are also due to the significant role of share market in the economy, and therefore Securities market is also considered as a barometer of the economy’s financial health.

Having said, one must know that the Indices in the Securities market such as Nifty or Sensex which comprises of most of the blue chip companies, which only represent shares which are active in trading, meaning thereby those shares having buy order or sell order (In technical terms, this is called high trading volume). These kinds of shares provide more liquidity to their investors.

“Liquidity of stock means you can easily sell your stock because of large by order”

Unfortunately, it is seen that despite having the good fundamentals most of the companies’ Securities are not so liquid due to lack of interests from buyer side. It means listing of securities does not automatically provide the liquidity to the Securities. So, who and how to decide the fate of these Securities. The answer to this question lies with the Market maker.

WHO IS MARKET MAKER 

A market maker is an entity who is a member of the stock exchanges such as NSE, BSE etc. which helps to stabilise the price of the company after listing of securities on the stock exchange or providing the liquidity to the Securities of those companies which are not actively traded. This mechanism is worked by offering the two-way quote i.e. buying or selling the securities by the market maker. In this way, market maker infuses the liquidity in those securities which are not frequently traded.

MECHANISM:

At this stage, we must understand why the need of market makers are realised or we can say how the present Screen based system of trading was not providing the level playing field to those shares which are not frequently traded.

Under the screen based system, orders placed by buyers and sellers are matched by a computer system. For example, Mr. A places an order to sell 50 shares of Reliance @ 1000 whereas on the other side Mr. B places an order to buy 50 shares of Reliance @ 1000, so now the computer system of the stock exchange matches both orders and complete the transaction. This is just a hypothetical case wherein we have taken only one buyer and one seller. In reality, order size, price may differ, which is altogether a separate topic to discuss. What we try to explain in this example is that this matching process can easily be done in case of securities which have high trading volume meaning thereby, securities are being kept on transferring by the investor. 

Now, let’s understand how market maker improves the activity level of Securities not traded frequently.

The diagram depicted shows that market maker will buy the particular share @ Rs. 500 and sell @ Rs. 505, and able to make a profit of Rs. 5. This bid-ask quote is called as a bid-ask quote. Normally, the spread is higher in case of illiquid shares because of the higher risk is borne by the market maker. 

REGISTRATION PROCESS:

The member broker who is interested to act as a market maker on NSE SME platform can apply for one-time registration. Refer circular Ref.No.: 798/2012 Download Ref.No. NSE/SME/MEM/21427 dated August 6, 2012.

Registration as market maker:

1. Submit application for registration as market maker as per Annexure 1(provided in the circular), Net worth certificate duly certified by a practicing chartered accountant along with board resolution;

2. NSE after it is satisfied that member can act as a market maker can grant approval to act as a Market maker; and

3. That approval is only as a registered Market Maker and does not constitute an approval for carrying out market for any security.

[1]GUIDELINES FOR MARKET MAKERS ON SME(SMALL AND MEDIUM ENTERPRISE) EXCHANGE / SEPARATE PLATFORM OF EXISTING EXCHANGE HAVING NATION WIDE TERMINAL

Market making is mandatory in respect of all scrips listed and traded on SME exchange.

“SME is a dedicated exchange for providing the trading platform in the shares of SME.”

Followings are obligations and responsibilities of the market maker:

1. The Market Maker shall be required to provide a 2-way quote for 75% of the time in a day. The same shall be monitored by the stock exchange. Further, the Market Maker shall inform the exchange in advance for each and every black out period when the quotes are not being offered by the Market Maker.

“Black out period is the duration of time when the market maker is restricted to buy or sell the securities because he may have some price sensitive information through which he can make abnormal profits.” 

2. The minimum value of scrip must be 100000 which is being sold. However, an investor with lesser holding can sell.

3. Execution of the order at the quoted price and quantity must be guaranteed by the Market Maker, for the quotes given by him.

4. There would not be more than five Market Makers for a share.

5. The Market Maker may compete with other Market Makers for better quotes to the investors.

6. Further, the Market Maker shall be allowed to deregister by giving one month notice to the exchange, subject to (g) above.

CONCLUSION:

There is no doubt about how significant role is being played by the market maker in the development of securities market, but there must be a constant check on market maker through regulatory intervention so that market will not be distorted.

[1] SEBI Master Circular on Administration of Stock Exchanges, Arbitration in recognised Stock Exchanges and Stock Exchanges / trading platform for Small & Medium Enterprises including guidelines for Market Makers. Dated 31st December 2010