Mifid II Fuels Auction Innovation

Terry Flanagan

Intraday auctions on exchanges could provide new liquidity for trading large blocks as new regulations change trading in Europe.

A white paper from broker Neonet Securities and LiquidMetrix, the analytics firm, said: “With the focus of buy and sell side communities on MiFID II, intraday auctions may provide an alternative option in the perennial search for liquidity. They could also provide an alternative to dark pool trading, especially as such trading is set to be capped under the new MiFID II proposals.”

The proposed MiFID II regulations place volume caps on trading of 4% of daily volume in an individual stock on any single dark venue as well as 8% of total average daily volume across all European dark pools from 2017. There are waivers for placing large-in-scale orders and trading in auctions.

Tim Wildenberg, chief executive of Neonet Securities, told Markets Media: “The market is attempting to change the way that liquidity is centralised and move away from the regulatory price waivers.”

Wildenberg added that current calculations show that under the 4% and 8% volume caps, most stocks would very quickly become ineligible to be traded as they are today.

“Regulators would like more liquidity to flow to better regulated platforms from broker crossing networks where not everyone has access,” Wildenberg added. “More business is likely to be done in auctions which concentrate liquidity at a single moment in time and have the potential to become a vehicle for thinking about different ways to access the same liquidity.”

The London Stock Exchange has said it will launch a midday auction late this year.

Brian Schwieger, head of equities at London Stock Exchange, said in the white paper this will be a very significant change to the trading day.

“The auction will allow participants to place orders in a truly confidential, yet price-forming environment via a well understood mechanism,” Schweiger added. “The 12.00 timing is based on market feedback, matching the current intraday auction in Germany. We are aware that institutional investors hope it will encourage European markets to follow suit, creating over time a significant and harmonised pan-European focus for liquidity at midday across the continent.”

Neonet said trading algorithms need to be ready to take advantage of this new potential source of liquidity.

“Participation and VWAP algos need to have good predictions of what proportion of volume is expected to trade in the new auction so trading schedules and participation rates stay on course to track benchmark prices,” said the paper. “The strategy for IS or opportunistic algorithms will be to get as much volume done as possible in the new auction, but additional best execution monitoring will be needed to make sure the prices achieved are fair and we are not either impacting the market ourselves or falling prey to some form of gaming.”

This week Aquis Exchange, the subscription-based venue which launched in 2013, launched a new order type to give members cheaper access to closing auctions across Europe. The order avoids the MiFID II volume caps as trading will be on lit venues and meet all pre- and post-trade transparency requirements.

“The closing auctions have become a monopoly so it is good that Aquis is being disruptive and introducing competition in pricing,” added Wildenberg.

Bloomberg reported this week that Hong Kong Exchanges & Clearing Ltd aims to to reintroduce daily closing auctions for some stocks in 2016.

Romnesh Lamba, the Hong Kong exchange’s co-head of global markets, told Bloomberg: “From a market structure point of view we are keen to implement it. It’s going to get a fair amount of support from the buy side as well as the large broker community.”

In February the New York Stock Exchange made a regulatory filing to begin a midday auction in NYSE-listed stocks with a lower average daily trading volume.

The NYSE filing said: “The midday auction is intended to consolidate volume, including orders of larger blocks of stock, for price discovery purposes in lower-volume securities to provide market participants with a single- priced execution intraday to supplement the existing opening and closing auctions. The exchange believes the proposed parameters for which stocks would be eligible to participate is reasonably designed to include those stocks that would benefit from such price discovery.”

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