Designated Sponsors: The Guardian Angels of Electronic Trading
How does the stock exchange work?
Investors who tend to choose second-line stocks, appreciate the
advantages offered by more liquid securities. Less liquid shares,
i.e., shares with a low exchange turnover, are more vulnerable to
high fluctuations in the market prices. They can even reach a
three-digit percentage. Usually, it would be very difficult to buy
or sell a security like this. The investor would first have to look
for a buyer/seller willing to trade at the price offered.
Fortunately, however, Designated Sponsors exist: They are market
participants that at any time do business with investors at
The main task of Designated Sponsors is to provide liquidity for the trading of a security. They do this by entering into the trading system binding buy or sell prices for less liquid securities, thus preventing imbalances between supply and demand. That makes it easier for investors to find trading partners. Thereby the Designated Sponsor competes with the other market participants in executing the order. They are typically asked to do so by the issuer of the share. Designated Sponsors are mainly banks or financial service providers that also advise and support the respective listed company in other areas. Often it may be the initial IPO advisor and later-on provider to the financial market that becomes a Designated Sponsor for the issuer of a security.
In the course of the new segmentation of the equity market quite a bit has changed for issuers. Most importantly – and with an impact on Xetra trading – companies no longer need a Designated Sponsor in order to be listed in a particular market segment or to be included in a selection index. Only less liquid shares and in general exchange-traded funds, that aim to be listed in the Xetra Funds segment at FWB Frankfurter Wertpapierbörse, (Frankfurt Stock Exchange) are required to enlist at least one Designated Sponsor.
For shares with a low trading volume, Designated Sponsoring is a very valuable service both for issuers and investors. When a share does no longer experience much activity and the trading figures go towards zero, at the latest, the importance of Designated Sponsoring will show. Using its own resources, the respective bank would then ensure liquidity and a market-driven valuation. Designated Sponsors are usually enlisted by the issuers. However, they can also voluntarily apply for admission.
At which point is a security deemed so illiquid that a Designated Sponsor is wanted for help? Two criteria are most decisive here: First of all, Deutsche Börse calculates the average order book turnover for each security traded in Xetra. The second criterion is the so-called Xetra Liquidiy Measure (XLM), which shows the implicit transaction cost and allows for a comparison between securities by trading cost. If the respective security has an average daily order book turnover of at least €2,5 million and furthermore an XLM of no more than 100 basis points, it belongs to liquidity class A. Titles in this class are assumed to be always liquid and tradable at market-driven prices without further support. Securities with a low turnover or an XLM of more then 100 basis points belong to liquidity class B and need at least one Designated Sponsor.