Distilling the differences between APs and ETF market makers

August 6, 2019

Jessica Clancy

Jessica Clancy
ETF Capital Markets Specialist
Vanguard ETF Capital Markets Desk

On the Vanguard ETF Capital Markets Desk we often get the question, "What's the difference between authorized participants (APs) and market makers?" While the difference may not mean much to your clients, it's worth understanding when you set up trades, especially bigger ones.

Offering an answer to the AP versus market maker question, a friend and former colleague on the team, Bill Arnold, used to say: "All bourbons are whiskey, but not all whiskey is bourbon."

What could Bill have possibly meant? I enjoy a bourbon from time to time, so I'll explain.

Most whiskey isn't bourbon

When you're contemplating a basic trade of an ETF, you'll likely look in the secondary market, where most ETF trading takes place. There you'll need to first find the quoted price and the number of shares available at that quote.

The firms establishing these quotes are ETF market makers—the whiskey of Bill's example. As we'll see below, the more plentiful the market maker population in general, the better the outcome for your clients.

ETF market makers come in all shapes and sizes: some are big banks, some are high-frequency trading firms, and some are more niche players. But they all have one thing in common—they're competing to win your trade.

Based on Bloomberg data, more than 150 market makers traded at least 1 million shares in U.S.-listed ETFs in 2018. Having multiple market makers in an ETF enhances liquidity by making more shares available for execution. Ultimately, competition is good for investors.

We've observed that as more market makers have entered the space and started trading ETFs, transaction costs have decreased. The chart below shows the falling spreads.

To summarize: When you place a trade, a market maker is the first stop and is the one that executes that trade for you.

More than 80% of all trades are handled solely in the secondary market.1

Again, that's the whiskey in Bill’s example. The other 20% is the bourbon. That'll take a bit more explaining, so here goes.

Sometimes only a bourbon—well, an AP—will do

There are times when a large trade occurs and the secondary market is just not deep enough, so a market maker decides it needs to create or redeem ETF shares. And therein lies the key difference between a market maker and an AP. An AP can create and redeem shares, while a market maker cannot.

If market makers want to create and redeem, they must meet additional requirements—just like bourbon—and become an AP, or they can just contract with an AP to create or redeem on their behalf.

How APs become APs

APs are often big banks, but not always. They become APs in part because they have signed contracts with ETF issuers such as Vanguard that allow them to create or redeem ETFs.

Again just like bourbon, APs must meet specific requirements before issuers take them on. ETF issuers like Vanguard want to ensure that the counterparties they approve as APs are resilient and capable in supporting the products.

So let's get back to Bill's whiskey versus bourbon comparison.

Annual ETF spread compression

Annual ETF spread compression

Source: Bloomberg, January 2012, to December 2018.

Note: Only ETFs with more than $100 million in assets under management were included.

Not all market makers are APs

The distinction boils down to this: An AP can act as a market maker—just as bourbon is a type of whiskey—but not all market makers are APs, or, in Bill's words, "Not all whiskey is bourbon."

The AP business model can work in a couple of ways; APs can operate as market makers, and they can also provide creation/redemption services for ETF market makers that are not APs. For that service, they collect a fee from their market maker clients.

The figure below shows these two ways an AP can operate in the context of a creation order. The first diagram depicts the life of an order when the AP is also acting as a market marker, while the second example traces that order when the AP is facilitating a creation order for an outside market maker.

Choosing between market makers and APs

As the figure shows, when you place an order for Vanguard S&P 500 ETF (VOO), you execute your order and you obtain shares. Sometimes APs and market makers are the same party, and sometimes they're not.

But does that affect your client, the end-investor? Not so much. There's really no evidence showing that you'll have a better experience if your order is executed by a firm that is purely an ETF market maker or one that is also an AP.

All this—whether an AP or a market maker executes your order—is behind-the-scenes stuff.

Your experience looks and feels the same in both scenarios.

Don't trade too much

The deeper significance of Bill's bourbon and whiskey analogy may lie in its limitations.

Which is to say that the demonstrable growth of AP and market maker participation is a clear positive in ETF markets to the extent that deeper liquidity and tightening bid-ask spreads allow investors to keep more of their money.

In other words, the more APs and market makers there are, the merrier.

That said, at Vanguard, we certainly don’t encourage trading too much, as excess trading can result in excess costs. And I certainly wouldn't encourage whiskey drinkers or bourbon drinkers like myself to drink too much, even though I do lift the occasional tumbler of Woodford Reserve, my favorite brand of bourbon.2

I hope this discussion helped to demystify the growing ETF ecosystem.

AP as market maker

AP as market maker

AP facilitates a creation order for another market maker

AP facilitates a creation order for another market maker

1 Vanguard, 2019. Exchange-traded funds: Clarity amid the clutter. Valley Forge, Pa.: The Vanguard Group. (Vanguard Commentary.)

2 For a whiskey to be classified as bourbon it must have a mash bill with at least 51% corn, distilled at 160 proof or less, and put in the barrel at 125 proof or less. Then it must be aged in a new white oak barrel. Finally, while all bourbon once had to come from Kentucky to qualify, these days it qualifies as bourbon as long as it’s made somewhere in the United States.

As always, please feel free to reach out to the Vanguard U.S. ETF Capital Markets Team if you would like to discuss anything about ETFs at 484-618-3837.


  • Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
  • All investing is subject to risk, including possible loss of principal.


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