Designated Market Makers (DMMs) - NYSE
Now that you understand the auction vs. dealer market distinction, let's look at the key player in the NYSE's auction model: the Designated Market Maker.
Role and Function of the DMM
- Formerly known as specialists, DMMs are assigned to specific securities on the NYSE
- Each listed security has one DMM responsible for maintaining a fair and orderly market
- DMMs operate both manually and electronically to facilitate price discovery
- DMMs must quote at the NBBO (National Best Bid and Offer) a specified percentage of the time
Remember: One security = one DMM on the NYSE. This is a fundamental structural difference from Nasdaq, which has multiple competing market makers per stock.
DMM Obligations
DMMs have five core obligations under NYSE rules:
| Obligation | Description |
|---|---|
| Maintain fair and orderly market | Must provide continuous two-sided quotes (bid and offer) in assigned securities |
| Facilitate price discovery | Particularly important during market openings, closings, and periods of significant imbalance |
| Provide liquidity | Must commit their own capital to buy or sell when there is insufficient public interest |
| Minimize price volatility | Must trade to dampen excessive price swings, not to amplify them |
| Manage the auction | Facilitate opening and closing auctions on the NYSE |
The Dual Obligation: Affirmative and Negative
This is one of the most-tested concepts in this unit. DMMs have two opposing obligations:
- Affirmative obligation: The DMM must step in and trade when needed to maintain a fair and orderly market: buying when no one else is buying, selling when no one else is selling
- Negative obligation: The DMM must step back when the public market is functioning well; the DMM should NOT trade for its own account when there are sufficient public orders
Exam Tip: Gotchas
A DMM should NOT trade for its own account when there are sufficient public orders to maintain an orderly market. The affirmative obligation kicks in only when public liquidity is insufficient. If the exam describes a DMM trading actively when there is plenty of public interest, that violates the negative obligation.
Principal vs. Agency Transactions
DMMs can act in two capacities:
- Principal transaction: The DMM buys or sells from its own inventory (acting as dealer)
- Must disclose principal capacity on the trade confirmation
- Trades as principal to fill gaps in supply or demand
- Agency transaction: The DMM executes a customer order against another order on the book (acting as broker)
- Earns a commission for agency trades
Key rule: A DMM cannot act as both agent and principal in the same transaction.
Exam Tip: Gotchas
A DMM cannot be agent AND principal in the same trade. Principal trades require disclosure on the trade confirmation; agency trades earn a commission. If the exam asks about a DMM filling a customer order from its own inventory while also earning a commission on the same trade, that is a violation.
NYSE Rule 104
Rule 104 is the core rule governing DMM behavior:
- DMMs must maintain a fair and orderly market in each security in which they are registered
- DMMs must maintain depth by dynamically adding liquidity when insufficient public liquidity exists
- DMMs have affirmative obligations to trade against the prevailing trend when necessary to reduce volatility
- DMMs have negative obligations not to trade for their own account when sufficient public interest exists
Exam Tip: Gotchas
The affirmative obligation means trading AGAINST the trend (buying on declines, selling on rallies), not going with the trend. When public interest is insufficient, the DMM steps in as principal; when public interest returns, the negative obligation requires the DMM to step back.