Goldman retreats from backstopping ETFs as costs rise
Goldman Sachs is said to be retreating from its role as a top lead market maker (LMM) for exchange-traded funds as smaller digital start-ups increasingly take up the mantle. The bank is said to have decided to pull back because of regulatory costs. LMMs help backstop markets by providing liquidity either by offering competitive buy-sell quotes or by committing their own capital. Larger banks like Goldman are under stricter regulatory rules than smaller firms, prompting many to exit the market. 
Goldman has told fund providers it is scaling back its role as a top lead market maker (LMM) for ETFs and has already slashed the number of funds it supports in that capacity, according to disclosures, fund managers and other trading firms this month.

Goldman Sachs Group Inc is pulling back substantially from trading that helps backstop the fast-growing use of U.S. exchange-traded funds, giving smaller firms an opportunity to grab market share.

Financial professionals sit in the Goldman Sachs booth on the floor of the New York Stock Exchange.

Relatively high regulatory and other costs of operating as an LMM prompted the pullback by Goldman, one of the few large banks remaining in that role, some people said.

A spokeswoman for Goldman declined to comment on the bank's market-making business.

The move signals the shifting landscape of making markets in many assets away from traditional broker-dealers towards smaller, electronic-focused upstarts.

LMMs are critical to keeping ETFs trading smoothly. While brokers-dealers can typically trade as they please, firms acting as LMMs must consistently offer competitive buy-and-sell quotes in their assigned ETFs, and they receive rebates on exchange fees. Some also provide start-up financing for the funds.

The LMMs risk some of their own capital to buy and sell ETFs to help maintain their liquidity.

Unlike smaller rivals, big banks like Goldman Sachs are subject to strict capital requirements by regulators, putting them at a disadvantage when it comes to costs in an already low-margin business.

ETFs attracted a record $348 billion globally in the first half of this year, compared to $123 billion at the same point last year, according to research service ETFGI LLP.

Despite the skyrocketing growth in ETFs, it can be hard to translate the LMM business into a high-margin operation.

Market making is a technology business as much as a trading enterprise, and involves finding the right price for funds holding dozens of stocks or bonds in a split second while making other trades to manage risk.

One industry veteran described the business as "scraping fractions of pennies all day."

Goldman continues to make issuing its own ETFs through its asset management unit a priority, however, even as it steps back from providing the infrastructure to keep such funds trading.