A liquidity provider, securities company that enters into contract with a listed company, keeps quoting bid and ask prices on the market, thereby facilitating the trade and maintaining stable prices for the stock.
The revised business regulations concerning the liquidity provider system was approved by the Financial Supervisory Commission on November 25, 2005.
Background
- Liquidity gap is considerably large between stocks because trades are matched upon order from traders and thus trading volumes are mostly concentrated in mid and large cap stocks with deep liquidity.
- In 2004, top 100 of 809 stocks listed on the Stock Market of KRX generated 83.1% of total trading value while bottom 500 stocks accounted for only 2.5% of the total.
- The widening liquidity gap has caused prices of low-liquidity stocks to be highly volatile and thus traders to avoid trading these stocks. Consequently, those stocks have persistently remained undervalued and become the key reason to lower investor confidence in the market.
- KRX has decided to introduce the liquidity provider (LP) system which is successfully operated for low-liquidity stocks in major European markets which are similar to the exchange in many ways.
- A securities company (LP) enters into a contract with a listed company and under the terms of the contract, it is obliged to provide liquidity by offering quotations in a way that reduces the gap between bid and ask prices for the stock of the company.
- Obligatory quotation for liquidity creation: if the gap between the highest bid price and the lowest ask price exceeds 3% during the regular trading hours (09:00?15:00), a liquidity provider should offer two-way obligatory quotations for volumes which are more than five times the trading unit to reduce the gap.
However, the requirements for obligatory quotation including bid-ask spread93%) and quotation volume (5 times) can be revised and specified in the contract (e.g.: 3%to 2%, 5 times to 10 times)
- Time limit for obligatory quotation: A liquidity provider should offer quotations within 5 minutes if such need arises. The five minute time limit is given as an LP needs time to assess the market situation and offer quotation.
- Greater transparency for LP’s transaction: separate accounts will be opened for LP trading and quotations offered by LPs will be monitored more strictly on a real time basis. In addition, LP trades will be subject to post-trade review and market surveillance regulations will be set for LP trading.
- For investors: reduced gap between bid and ask prices will allow investors to trade at more favorable prices
- For listed companies: corporate value will be raised as stocks will be more fairly valued.
- For securities companies: sources of revenue will be diversified (e.g. fee revenue, business enhancement)
- For the market: the market will be improved qualitatively and the trading scheme will be brought on part with international standards.