Market making plays a crucial role in ensuring liquidity and smooth trading operations in global financial markets. In many countries, official market makers or specialists are designated to provide bid-ask quotes and facilitate trading. However, Indian stock exchanges NSE,BSE does not have an official market-making system. Despite this, liquidity remains strong, and bid-ask quotes are continuously supplied.
So, the big question is: Who supplies bid-ask quotes in India’s stock market if there are no official market makers? Let’s explore the key players behind liquidity provision in India’s trading ecosystem.
1. High-Frequency Trading (HFT) as Unofficial Market Makers
Although there are no official market makers, HFT firms and proprietary trading desks act as de facto market makers in India. These firms use algorithmic trading strategies to place bid and ask orders at high speeds, capturing spreads and arbitrage opportunities.
Why Do HFT Firms Provide Liquidity?
- They profit from the bid-ask spread by continuously placing limit orders.
- They engage in market-making strategies like statistical arbitrage, order flow prediction, and latency arbitrage.
- Co-location facilities (introduced in 2010 by NSE) reduce latency and give HFT firms an edge in executing market-making strategies.
However, HFT firms are not obligated to provide liquidity, unlike official market makers in other countries. If market conditions become unfavorable (e.g., sudden volatility or regulation changes), HFTs can quickly shift away from market-making to opportunistic trading strategies.
2. Proprietary Trading Firms and Institutional Investors
Many proprietary trading firms and institutional investors also provide liquidity by submitting passive limit orders. These firms engage in various strategies, such as:
- Cash-Futures Arbitrage – Exploiting price differences between cash and futures markets.
- Inter-Exchange Arbitrage – Trading the same stock across NSE and BSE for small price differences.
- VWAP & TWAP Execution – Using algorithms to gradually buy or sell large volumes to minimize market impact.
Since these traders frequently enter large volume trades, their passive orders contribute significantly to market liquidity.
3. Retail Investors and Small Participants
Retail traders and investors also contribute to the bid-ask spread through limit orders. However, their impact is much smaller than institutional investors and HFT firms.
Retail traders tend to place:
- Market Orders (taking existing liquidity rather than providing it).
- Limit Orders (which add liquidity but are often small in volume).
Thus, while retail investors play a role in order flow, the bulk of liquidity provision comes from larger institutional players.
4. Exchange Incentives for Liquidity Provision
Even though NSE and BSE do not have official market makers, they encourage liquidity provision through indirect incentives:
Co-Location Services – HFT firms and proprietary desks can deploy servers at NSE’s data center for faster execution.
Trading Fee Rebates & Discounts – High-volume traders receive fee reductions, encouraging liquidity provision.
These incentives motivate traders to place limit orders and help maintain a tight bid-ask spread, ensuring market efficiency.
5. Impact of SEBI’s 2018 Order-to-Trade (OTR) Regulation
Before 2018, market-making HFTs frequently placed and canceled orders to maintain tight spreads. However, in 2018, SEBI introduced penalties for excessive order modifications to prevent potential market manipulation.
Impact of the OTR Regulation:
Market-Making Activity Declined – HFTs reduced their passive orders to avoid penalties.
More Opportunistic Trading – Traders shifted toward liquidity-taking strategies instead of providing liquidity.
Potential Reduction in Liquidity – A drop in market-making activity may have made it harder for retail traders to execute large orders efficiently.
This shows how regulation can impact the liquidity supply in markets without official market makers.
6. The Future of Market Making in India
As technology advances and algorithmic trading grows, HFT firms and institutional investors will continue to dominate liquidity provision in Indian markets. However, their ability to act as market makers depends on:
🔹 Regulatory Environment – Further restrictions could discourage passive market-making strategies.
🔹 Technological Infrastructure – Faster execution speeds will make liquidity provision more efficient.
🔹 Market Conditions – High volatility may lead traders to withdraw liquidity rather than provide it.
Final Thoughts
Even though India lacks official market makers, bid-ask quotes and liquidity are supplied by:
✅ HFT firms & algorithmic traders
✅ Proprietary trading desks & institutional investors
✅ Arbitrage and passive trading strategies
✅ Retail limit orders (minor contribution)
Regulatory changes, such as the 2018 SEBI rule on high order-to-trade ratios, have reduced passive market-making, potentially impacting liquidity. The future of market making in India will depend on how SEBI balances market efficiency with regulatory concerns.
Despite the absence of a formal market-making system, India’s stock market remains liquid, competitive, and technologically advanced, primarily due to the role of HFTs and institutional traders.
