October 25, 2012 / 10:06 PM / 7 years ago

Nasdaq ETF order-type proposal raises questions

NEW YORK (Reuters) - Nasdaq OMX Group (NDAQ.O) has proposed a new order type for exchange-traded funds (ETFs) that may comfort investors who feel there is not enough transparency in the pricing of some securities.

But some observers and ETF providers say the proposal may be a solution in search of a problem - and might actually result in some investors’ trades not getting filled.

Nasdaq plans to introduce a new order type aimed at boosting investor confidence in ETFs by providing more transparency into the underlying value of the products, according to a regulatory filing with the U.S. Securities and Exchange Commission.

ETFs are investment vehicles that own an array of stocks or bonds, similar to mutual funds, but trade on public exchanges.

The new limit order type would allow investors to peg the price of orders for U.S. domestic ETFs with the intraday net asset value (INAV) of their component stocks, rather than to the end-of-day net asset value, which is calculated at the previous close, according to SEC filing, dated October 12.

Exchange-traded product issuers must provide an INAV at least every 15 seconds for their products. But the INAV is used only as a post-trade analytic tool that investors can use after buying an ETF to see if the price paid was close to the actual value of the underlying components.


With an estimated 2,000 variations, and more than 50 trading venues, many traders and investors have complained the markets have grown too complex.

“Knowing how hard (exchanges) compete for execution, it’s just another variation to help Nasdaq attract execution to their venue,” said Eric Pollackov, a former NYSE Euronext NYX.N executive who is now managing director of ETFs at Schwab.

The proposal is in the midst of a 21-day public comment period required by the SEC, and therefore Nasdaq cannot speak about the matter, a spokesman for the company said.

While Nasdaq’s proposal would give investors choice in how they place orders and educate retail investors about how INAV quotes work, it seems to be “more of a solution in search of a problem,” said David Nadig, director of research at IndexUniverse LLC, which conducts research on the ETF industry.

The new order type would only apply to domestic equity ETFs that trade in the United States, and most of those are very liquid and thus trade at fair price execution, Nadig said.

Out of the 1,438 U.S. ETFs, only 347 are domestic equity funds, not including leveraged and inverse ETFs, according to IndexUniverse. These are primarily large, liquid, equity-based ETFs, Nadig said.

For those few situations in which domestic equity ETFs are trading at wide bid-ask spreads, the danger with this kind of order is that investors who use it may risk not getting their orders filled, he said.

“With this kind of order you are effectively saying you only want to get executed at INAV, which is like saying you want to get executed inside the spread,” Nadig said. “But that might never happen and that means there is a real risk of the order not getting filled.”

A conventional market order would still be available to investors, Nasdaq said in its filing.


“The INAV is intended to approximate the fair value of the securities held in the portfolio by the ETF and should closely represent the value of the fund during the trading day,” Nasdaq said in the filing, reported on earlier by Ignites.

Since the order would be repriced throughout its life as the value of the underlying portfolio changes, it would eliminate investors’ concerns about the value of the fund’s underlying portfolio being drastically different from their execution price, Nasdaq said.

It is not clear if there has been any significant investor concern about this issue.

But the proposal from Nasdaq does raise the concern that calculations on INAV quotes will not always be accurate, say some ETF executives. That’s because ETF issuers hire third-parties to calculate INAV quotes, which are then distributed by the exchanges.

If those calculations are wrong, it would cause problems for investors who place the orders, said an executive at an ETF provider who spoke anonymously because his firm is still reviewing the proposal. To avoid that, there would need to be more monitoring of these prices, ETF executives said.

“Basing your investment decision on a third-party valuation service always makes me nervous,” Pollackov said.

Nasdaq said in its filing that in the event the INAV data feed for a particular ETF were to be compromised, “the use of the INAV pegged order type for that ETF would be suspended and orders utilizing the INAV pegged functionality for that ETF already in the system would be canceled.”

Reporting By John McCrank and Jessica Toonkel in New York; Editing by Jennifer Merritt and Leslie Adler

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