Market Makers vs Authorized Participants: Who Does What on the PSX?

There's a line I've heard repeatedly from brokerage reps across Karachi when investors ask about ETF pricing: "Don't worry, the market maker handles it."

They're not entirely wrong. But they're not entirely right either. Because the entity actually keeping your ETF priced correctly isn't necessarily the Market Maker - it's the Authorized Participant. And if you don't know the difference between the two, you cannot diagnose why your ETF behaved strangely on a volatile trading day - or know when to wait before placing your order.

Let me map this out clearly.

The One-Line Distinction

Market Makers ensure you can always trade - they guarantee there's a buyer when you want to sell, and a seller when you want to buy.

Authorized Participants ensure you're always trading at a fair price - they correct premiums and discounts by creating or redeeming ETF units directly with the fund manager.

Both are essential. Neither is a substitute for the other. And confusing them will consistently cost you money.

Side-by-Side: What Each Entity Actually Does

Market Makers: The Retailer of the ETF World

Think of the Market Maker as the shopkeeper who's always open, no matter what's happening outside.

Under PSX regulations, every ETF listed on the exchange is required to have at least one designated Market Maker. Their core job is to continuously post a two-sided quote throughout the trading day:

• A bid price: the price at which they'll buy ETF units from you if you want to sell
• An ask price: the price at which they'll sell ETF units to you if you want to buy

Without a Market Maker, trading a low-volume ETF on the PSX would be genuinely painful. You might put in a sell order at what you consider a fair price and wait for hours - or the entire session - with no counterparty. The Market Maker eliminates this problem. They absorb your trade using their own inventory, ensuring you can always transact.

They earn their profit on the bid-ask spread - the gap between their buying price and their selling price. On well-traded PSX ETFs with active Market Makers, this spread can be just a few paisa. On thinly traded ETFs, it can expand to 20, 30, or even 50 paisa.

NOTE The bid-ask spread isn't just the Market Maker's revenue. It is a direct, real transaction cost to you. Every time you buy at the ask price and later sell at the bid price, you absorb the full spread. In a thinly traded ETF with a 40-paisa spread on a PKR 10 ETF, that's a 4% round-trip cost on top of your expense ratio - before any market movement at all.

PSX Market Maker Obligations in Practice

The PSX doesn't let Market Makers simply show up occasionally and call it done. Their contract specifies:

• A minimum quoting time (they must be present and quoting for a minimum percentage of the trading session)
• A maximum spread (they cannot quote excessively wide spreads that make trading prohibitively expensive)
• A minimum quote size (they must be willing to absorb at least a minimum number of units per quote)

When a Market Maker fails to meet these obligations consistently, the PSX can review their designation. In practice, on the PSX, Market Maker compliance is something investors should monitor indirectly - by watching whether spreads on their ETF routinely stay narrow or frequently blow out.

Authorized Participants: The Structural Price Correctors

Where the Market Maker works entirely within the secondary market (just like any regular buyer or seller on the PSX), the Authorized Participant operates at a fundamentally different structural level.

The AP is the only entity with a direct contractual pathway to the fund manager's primary market - the ability to create brand new ETF units or permanently redeem existing ones. This is not available to retail investors, institutional investors, or even Market Makers acting outside their AP role.

When the ETF's market price drifts significantly from its NAV, the AP steps in to correct it structurally:

• ETF at a premium (market price > NAV): The AP buys the underlying stocks in the open market, assembles them into a creation basket, hands them to the AMC, and receives new ETF units at NAV. They sell those new units at the higher market price. Increased supply → price falls toward NAV. Premium corrected.

• ETF at a discount (market price < NAV): The AP buys the discounted ETF units on the PSX, redeems them with the AMC for the underlying stocks at full NAV value, then sells the stocks at the market. Reduced ETF unit supply + buying pressure on the unit → price rises toward NAV. Discount corrected.

This creation-redemption mechanism is not optional or informal - it is the defining architectural feature that makes ETFs categorically different from closed-end funds, which have no such correction mechanism and can trade at persistent, uncorrected discounts for months or years.

Can the Same Firm Do Both Jobs?

Yes and on the PSX, this is the norm rather than the exception.

Given the relatively early stage of Pakistan's ETF market, a single large brokerage firm may serve simultaneously as both the designated Market Maker and the Authorized Participant for the same ETF. The functional roles remain distinct, but the same trading desk may execute both.

This consolidation of roles has an important implication for investors: both liquidity and pricing can deteriorate simultaneously if that single institution withdraws from both functions during a stressed market session. On developed markets with multiple APs and MMs per ETF, this concentration risk is lower. On the PSX, it is something to be aware of.

A Real Scenario: Reading the Difference During a Volatile Session

Imagine it's January 2025. An unexpected interest rate hike is announced midday. Markets sell off sharply. You pull up HBLTETF (HBL Total Treasury ETF) on your trading screen.

You notice two things simultaneously:

1. The bid-ask spread has jumped from 5 paisa to 40 paisa.
2. The market price is also 2.5% below the iNAV.

These are two separate problems with two distinct root causes:

• The 40-paisa spread is a Market Maker problem - they are quoting cautiously because they don't want to accumulate large ETF inventory at uncertain prices during a volatile session. They're protecting themselves by widening their margin.
• The 2.5% discount to iNAV is an Authorized Participant problem - nobody has executed the arbitrage trade yet to buy the discounted ETF units and bring the price back to fair value. Perhaps the economics don't justify it at this discount level, or the AP desk is busy managing other positions during the sell-off.

If you hit "Sell" with a market order right now, you pay the full cost of both problems simultaneously:

• You sell at the bid: PKR 0.40 per unit below what you could have achieved with a limit order
• You sell at 2.5% below the actual fair value of your underlying holdings

In a PKR 500,000 position, that could easily represent PKR 12,500–15,000 of unnecessary loss in a single bad transaction.

TIP The dual-check protocol for volatile PSX sessions: When markets are moving fast, look at two numbers before trading any ETF. (1) The bid-ask spread - if it's wider than usual, the Market Maker is stressed. (2) The deviation from iNAV - if it's more than 1%, the AP hasn't corrected the gap yet. In either case, a limit order near the iNAV is your best protection. Wait for the market to settle if you're not in a forced-exit situation.

Why This Matters When Choosing Between PSX ETFs

Most Pakistani ETF comparisons focus on expense ratios, fund size, and index tracking records. Very few investors look at Market Maker quality and Authorized Participant activity - but these factors are significant determinants of your real-world trading cost.

A practical due-diligence framework when comparing ETFs:

Look at historical bid-ask spreads: A consistently narrow spread (a few paisa on a PKR 10 ETF) indicates an active, well-funded Market Maker. A spread that regularly hits 20-30 paisa indicates thin MM activity and those paisa come out of your pocket.

Look at historical premium/discount records: Some ETF data providers track how often and how far an ETF has traded above or below its NAV. Consistently small deviations (under 0.5%) indicate active AP participation. Frequent, large deviations (1–3%+) suggest the AP is less engaged with that fund.

Check the ETF's AUM and daily volume: These are indirect proxies for MM and AP activity. Larger, more actively traded ETFs attract better institutional infrastructure. Very small ETFs (sub-PKR 500 million AUM) on the PSX often have more erratic pricing as a result.

Frequently Asked Questions

If both the MM and AP are from the same firm, what happens when that firm has internal issues? Exactly what you'd expect - both liquidity and pricing quality can deteriorate simultaneously. This is a known concentration risk on the PSX. It's one reason why ETF investors should prefer funds with demonstrably active market infrastructure, and why watching for unusually wide spreads or persistent NAV gaps is worthwhile.

Does the Market Maker hold ETF units in inventory permanently? No. The Market Maker maintains a dynamic inventory - buying units when selling pressure is high (building inventory), selling units when buying pressure is high (depleting inventory). They manage this position continuously and typically don't carry large overnight inventory risk. If their inventory gets too large (too many units bought) or too small (units depleted), their quoting behaviour changes - which is when you'll see spreads widen or quotes disappear temporarily.

What happens if there's no market maker on a PSX ETF? In theory, ETFs must have a designated Market Maker to remain listed. If an ETF's Market Maker withdraws and no replacement is found, the PSX can initiate a delisting process. In practice, for active PSX-listed ETFs, this scenario is unlikely but not impossible - particularly for newer or smaller funds where the Market Maker's fee may not justify continued engagement.

How do I find out who the AP and MM are for a specific PSX ETF? This information is disclosed in the ETF's prospectus, which is available on the SECP's company filings portal and on the AMC's official website. For a quick reference, many AMC factsheets also name the designated Market Maker.

The Bottom Line

Market Makers and Authorized Participants are not interchangeable. They solve different problems:

• If you can't find a counterparty for your trade, that's a Market Maker failure - liquidity has dried up.
• If you can trade but you're trading at a price far from fair value, that's an Authorized Participant failure - the arbitrage mechanism hasn't corrected the gap.

Understanding which problem you're facing lets you respond correctly: use limit orders near the iNAV, be patient during volatile sessions, and prefer ETFs with demonstrably active institutional infrastructure.

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Read next:

• How Authorized Participants Keep ETF Prices Honest on the PSX
• NAV vs Market Price: Why Your ETF Screen Price Isn't Always 'Fair Value'
• Pakistan ETF Comparison: How to Choose Between All 9 PSX ETFs