Want to invest in exchange-traded funds (ETF) but hesitate when you see low trading volume? Or curious why the market price of an ETF always stays close to its net asset value (NAV)? Behind this is a group of invisible market drivers, “ETF market makers”. They are the key role that ensures market liquidity. This article will clearly explain how ETF market makers (dealers) operate and clarify the roles of ETF liquidity providers and ETF participating dealers, explaining their actual operating model within the Hong Kong ETF dealer ecosystem, so you can fully understand the source of ETF liquidity and invest with greater confidence.
ETF market makers (commonly known as dealers) play an indispensable role in the ETF ecosystem. They are like the lubricant of the market, ensuring that the entire trading mechanism operates smoothly. Without them, the trading experience of ETFs would be completely different. Their core functions are mainly twofold:
Imagine this situation: when you want to buy an ETF but there happens to be no seller in the market, or when you want to sell but cannot find a buyer. This situation causes trades to be unable to complete immediately or even fail to execute, which is the problem of “insufficient liquidity”.
The responsibility of ETF market makers is to continuously provide “bid quotes” (Bid) and “ask quotes” (Ask) in the market. Regardless of market conditions, they are willing to take or sell positions within a reasonable spread range. This means that even if the daily trading volume of an ETF appears low, investors can still buy or sell at any time based on the dealer’s quoted price without worrying about the situation of “having a price but no market”. They provide a constant source of trading counterparties for the market and are an important foundation of confidence for retail investors.
The value of an ETF is determined by the “net asset value” (NAV) of the basket of assets it holds. However, the price traded in the public market (market price) is influenced by supply and demand. Without the adjustment of market makers, when large buy or sell orders appear in the market, the market price can easily deviate significantly from NAV, creating large premiums or discounts that harm investors’ interests.
Market makers use a sophisticated arbitrage mechanism (explained later) to continuously monitor the gap between the market price and NAV. Once the gap becomes large enough to cover trading costs and generate profit, they enter the market to intervene, bringing the market price back close to NAV. At the same time, competition among market makers also narrows the bid-ask spread, reducing investors’ trading costs. For a healthy ETF, the bid-ask spread is usually very small, and market makers play an important role behind this.
In the operation of ETFs, the terms “participating dealer”, “liquidity provider”, and “market maker” are often mentioned. They work closely together but have different roles. Simply put, they are like different participants in the chain from the “production” to the “retail” of ETFs.
Participating dealers (abbreviated as PD) are the only institutions that can deal directly with ETF issuers (fund companies). They are the players in the “primary market” and are responsible for the “creation” and “redemption” of ETF units.
PD can be understood as the “wholesaler” of ETFs. They do not serve retail investors directly but are responsible for adjusting the total supply of ETFs in the market.
Liquidity providers (LP) and market makers (MM) play very similar roles and in the Hong Kong market are often considered synonymous. They are the players in the “secondary market”, which is the market where we trade on the stock exchange. Their main responsibility is to provide quotes for ETFs and ensure market liquidity.
They obtain ETF units from PD (or buy them directly in the market) and then place buy and sell orders on the exchange to earn a small spread in between. They are the “retailers” of ETFs, directly serving ordinary investors like us. Every ETF listed on the exchange must have at least one market maker providing quotes.
To understand more clearly, the entire process can be summarized as follows:
ETF ecosystem explained: Division of roles from the primary market to the secondary market.
It is worth noting that many large financial institutions hold both PD and MM qualifications at the same time and play multiple roles. This allows them to conduct arbitrage operations more efficiently and maintain market stability.
| Role | Primary Market |
Main Responsibility |
Trading Counterparty |
| Participating Dealer (PD) | Primary Market | Create and redeem ETF units, adjust total supply | ETF issuer |
| Market Maker (MM) / Liquidity Provider (LP) | Secondary Market | Provide continuous bid and ask quotes, ensure market liquidity | General investors |
ETF dealers (mainly institutions that simultaneously act as PD and MM) are able to stabilize market prices not out of goodwill but because a powerful “arbitrage mechanism” operates behind the scenes. This mechanism ensures that the market price of an ETF does not deviate significantly from its true value (NAV) for long periods. This process is known as ETF arbitrage.
Assume an ETF tracking the Hang Seng Index has an NAV of HKD 100, but due to strong market demand, the market price has been driven up to HKD 101. This is called a “premium”.
The arbitrage process is as follows:
This process not only brings profit to the dealer but also increases the supply of ETF units in the market through their selling activity, helping to push the overheated market price back toward the NAV level of HKD 100.
Conversely, assume market panic selling causes the ETF market price to fall to HKD 99 while its NAV remains HKD 100. This is called a “discount”.
The arbitrage process is as follows:
Similarly, the dealer’s buying activity in the market absorbs excess selling pressure, helping to push the undervalued market price back toward the NAV level of HKD 100.
After understanding the theory, let us look at the actual situation in the Hong Kong market. As one of Asia’s leading ETF markets, Hong Kong has a mature market maker system that ensures efficient market operation.
In Hong Kong, institutions acting as ETF dealers and participating dealers are usually large international investment banks and local securities firms. They possess strong capital, advanced trading systems, and professional teams. Common market participants include:
This list is not fixed. For investors who wish to check the market maker of a specific ETF, the most authoritative source of information is the official website of Hong Kong Exchanges and Clearing (HKEX). HKEX regularly publishes the list of exchange-traded product securities dealers for each ETF, ensuring that the information is public and transparent.
Although dealers ensure basic liquidity, the trading activity and efficiency of different ETFs still vary. As a smart investor, you can evaluate the liquidity of an ETF through the following three indicators.
A: According to the regulations of Hong Kong Exchanges and Clearing, all listed ETFs must appoint at least one market maker. Therefore, in theory there is no situation of “no dealer”. Even if an ETF has very low trading volume, the market maker still has the responsibility to provide bids and ask quotes to ensure that investors can enter and exit the market. Of course, under extreme market conditions, liquidity may decline and the bid-ask spread may widen, but the risk of being completely “unable to sell” is extremely low.
A: The profit of ETF market makers mainly comes from two sources: first, earning the bid-ask spread by providing quotes in the secondary market; second, profiting from arbitrage between the primary and secondary markets when the market price deviates from NAV. Their profit model relies on accumulating small but stable gains through high trading volume.
A: No. Participating dealers (PD) only conduct large-scale creation and redemption transactions with ETF issuers in the primary market. The trading threshold is extremely high, (usually tens of thousands or even hundreds of thousands of ETF units). As retail investors, all our trades are conducted in the secondary market (the Hong Kong Exchange). The counterparty may be other investors, or more commonly, an ETF market maker.
A: Yes. Hong Kong Exchanges and Clearing has strict regulatory requirements for ETF market makers, including the duration of quotes, maximum bid-ask spread, and minimum quote size. If a market maker fails to fulfill its responsibilities, HKEX may issue warnings or even impose penalties. This regulatory mechanism ensures that market makers must actively fulfill their responsibilities and maintain market quality.
In summary, ETF market makers, liquidity providers, and participating dealers are the fundamental pillars that maintain the healthy operation of the ETF market. Through sophisticated creation, redemption, and arbitrage mechanisms, they ensure ETF liquidity and price stability, allowing investors to participate in the market conveniently and at low cost. For smart Hong Kong investors, understanding how ETF dealers operate helps you more accurately evaluate the trading efficiency and hidden costs of the ETF you are interested in, move beyond the misconception of “judging only by trading volume”, and make better investment decisions.
