What is a market maker?

Market makers quote two prices for the same security at the same time: a bid at which they buy and an ask at which they sell. The ask is higher than the bid, and the difference is the spread. An investor who wants to sell finds a buyer in the market maker, even when no other investor is buying at that moment.

Article 4(1)(7) of MiFID II gives the market maker definition: a person "who holds himself out on the financial markets on a continuous basis as being willing to deal on own account by buying and selling financial instruments against that person's proprietary capital at prices defined by that person". Explained without the legal wording, the meaning is this: a dealer that always shows prices and carries the risk of the positions it takes on.

In stock trading, a market maker keeps a share or an ETF tradable on an exchange by posting binding quotes in the order book. On Xetra, the designated market makers are called Designated Sponsors. Deutsche Börse describes them as "market participants who post binding buy and sell offers for the trading of less liquid securities". A share that misses the Xetra liquidity criteria needs at least one Designated Sponsor for admission to Xetra trading, and an ETF issuer needs at least one for each product.

At Wiener Börse, market makers in most segments must quote for at least 80% of the daily observation period from 9:00 a.m. to 5:30 p.m. on a monthly average, in minimum sizes of EUR 7,500 to EUR 35,000 and within a maximum spread of 0.65% to 5%. Wiener Börse rewards liquidity providers that meet their duties with reduced transaction fees.

Under MiFID II, market making is a strategy of an algorithmic trading firm, and the strategy brings duties toward the trading venue. Article 17(4) sets the market making definition in MiFID II: the firm posts "firm, simultaneous two-way quotes of comparable size and at competitive prices" on one or more venues, "with the result of providing liquidity on a regular and frequent basis to the overall market".

Such a firm has to make markets continuously during a set share of the venue's trading hours and sign a binding written agreement with the venue (Article 17(3)). Delegated Regulation (EU) 2017/578 makes the agreement mandatory once a firm quotes in this way for at least 50% of the daily hours of continuous trading on half of the trading days in a month.

A market maker trades on its own account, while a broker executes orders for its clients. MiFID II keeps the two apart: Article 4(1)(5) covers the "execution of orders on behalf of clients", Article 4(1)(6) covers "dealing on own account". A broker earns a commission and takes no price risk. A market maker earns the spread and holds the position.

Liquidity provider is the wider term. Wiener Börse uses it for every participant with a quotation duty. Besides market makers and MiFID market makers, it has BBO market makers, which quote a whole basket of instruments. Up to three different liquidity providers can quote one instrument in continuous trading with auctions.

A market maker in crypto quotes buy and sell prices on a crypto-asset trading platform, as it would on a stock exchange. Under Article 76(9) of MiCA, a platform operator in the EU has to publish the bid and ask prices and the depth of trading interest on a continuous basis during trading hours.

Decentralized finance replaces the market maker with software. The Uniswap documentation describes the protocol as "an automated market maker (AMM)" that works "instead of relying on order books". Traders swap tokens against a liquidity pool, and the pool sets the price with the constant product formula x * y = k, where x and y are the reserves of the two tokens. A large trade relative to the pool moves the price more than a small one.

In Germany, a trading participant applies to the Frankfurt Stock Exchange for admission as a Designated Sponsor on Xetra. Xetra is the trading venue of the Frankfurt Stock Exchange for equities, ETFs and ETPs, open from 9:00 a.m. to 5:30 p.m., and Designated Sponsors make continuous trading possible there for less liquid securities. BaFin supervises investment firms, and the Exchange Supervisory Authority of Hesse supervises the proper conduct of trading on the exchange. In Austria, liquidity providers sign a quotation contract with Wiener Börse, and the exchange operator itself needs a license from the FMA under § 3(2) Börsegesetz 2018. MiFID II applies in both countries.

Switzerland is outside the EU, so these rules do not apply there. SIX runs a Quote Driven Market for ETFs, ETPs and sponsored funds, in which prices come from quotes and trading stops when no quote is available. FINMA authorizes stock exchanges under Article 4 of the Financial Market Infrastructure Act. This page gives no legal advice.