A core liquidity provider is a financial institution that acts as a go-between in the securities markets. These institutions buy large volumes of securities from the companies that issue them and then distribute them in batches to financial firms, which will make them available directly to retail investors.

The term core liquidity provider describes the function of these firms: They simultaneously buy and sell shares of a security to ensure that it is always available on demand. A core liquidity provider is also known as a market maker.

Core liquidity providers are typically institutions or banks that underwrite or finance equity or debt transactions and then make a market or assist in the trading of the securities.

Understanding Core Liquidity Providers

Ideally, the core liquidity provider brings greater price stability to the markets, enabling securities to be distributed on demand to both retail and institutional investors. Without liquidity providers, the liquidity or availability of any given security could not be guaranteed, and the ability of buyers and sellers to buy or sell at any given time would be diminished.

Core liquidity providers make a market for an asset by offering their holdings for sale at any given time while simultaneously buying more of them. This pushes the volume of sales higher. But it also permits investors to buy shares whenever they want to without waiting for another investor to decide to sell.

The activities of core liquidity providers sustain many routine practices in the market, such as hedging. In the commodities markets, for instance, farmers and food processing companies invest regularly to protect their businesses against declines or increases in future crop prices. Core liquidity providers help make this possible by ensuring that there is a liquid futures market for agricultural commodities.

A key characteristic of core liquidity providers is that they continually provide liquidity in all market conditions—not just when they find it advantageous to buy or sell a security. Unlike traders, their business model is not dependent on securities prices.

The Types of Core Liquidity Providers

A bank, financial institution, or trading firm may act as a core liquidity provider. The different business models and capabilities of these liquidity providers allow them to serve the market in different ways.

Banks

Banks provide liquidity to many different types of financial markets. Banks with large balance sheets can accommodate sizable transactions, enabling them to make markets for various financial assets. For example, the world's largest banks are core liquidity providers in the foreign exchange markets.

Financial Institutions

Other types of financial institutions play key roles in shoring up the liquidity of various asset classes. For instance, securities firms and other financial companies serve as designated market makers (DMMs) for the New York Stock Exchange. DMMs are among the exchange's core liquidity providers, responsible for the availability and orderly trading of an assigned list of stocks. This means they take the other side of the trade when there is an imbalance of buying and selling in the market.

Trading Firms

Large trading firms serve as market makers across the capital markets, including those for equities, fixed-income securities, and derivatives. When a retail investor buys a security from a trading firm that is acting as principal, the firm fills the order using its own inventory, allowing it to benefit from the bid-ask spread.

The Main Functions of Core Liquidity Providers

Core liquidity providers add stability to the markets. By keeping financial products consistently available in the market, liquidity providers ensure that traders can buy and sell any quantity of assets at any moment for a mutually agreed price.

More specifically, core liquidity providers play the following key roles in the financial markets:

Balancing Out Large Orders

When an investor with a large amount of capital buys and sells extensive quantities of an asset, the impact on prices and other investors could be dramatic. Liquidity providers help the markets maintain equilibrium even in the face of large transactions.

Reducing Spreads

Enhanced liquidity comes with the benefit of lower spreads, the difference between the ask and bid prices of assets in the market. Being able to buy or sell at a more advantageous price and with a lower risk of price slippage effectively means lowering the trading costs for market participants.

Underwriting Initial Public Offerings

Perhaps the best-known core liquidity providers are the institutions that underwrite initial public offerings. When a company goes public on a stock exchange, it selects an underwriter to manage the process. The underwriter buys the stock directly from the company and then resells it in large batches to large financial institutions who then make the shares available directly to their clients.

The Bottom Line

A core liquidity provider is an intermediary that trades significant quantities of assets to help ensure that market participants can consistently buy and sell assets when they wish. Liquidity providers perform important functions in the market such as encouraging price stability, limiting volatility, reducing spreads, and making trading more cost-effective. Banks, financial institutions, and trading firms are key players in providing liquidity to different parts of the financial markets.