I just got off a call with a mate of mine from my energy trading days and we were discussing market making on exchanges.
He said he knows of a company that spent almost a year negotiating a fairly straight-forward arrangement (governed by a business contract) to provide liquidity on some markets for a fairly major exchange. I just think about all of the person-hours that went into that negotiation - traders and lawyers aren’t cheap!
In any case, the main points of their negotiation for a market making contract were:
- Obligations - typically structured as placing volume at a contractually agreed maximum bid/ask spread (%), with negotiation around how “often” you need to supply this volume, including specification of whether you need to refresh prices after they trade.
- Penalties - there’s an option to choose whether to be a “voluntary” market maker, which means that you don’t get penalised if you don’t provide liquidity. Otherwise, your rewards will be reduced.
- Incentives / rewards - structured as fee rebates - which basically means you’re not “earning” money, you’re just paying less for using that market for other strategies.