21 January 2019

ESMA publishes responses to Call for evidence on periodic auctions for equity instruments

AFME

AFME agrees that many factors have contributed to the market share gain of Frequent Batch Auctions (FBA) but does not agree that FBAs are a substitute for dark trading or a means of circumventing the Double Volume Caps (DVC). Instead, AFME members and their clients find that FBAs, similar in functionality to Conventional Periodic Auctions (CPA), offer favourable execution outcomes and have been a positive market structure evolution for clients.  New MiFID II order handling rules and execution data quality reporting require firms to take into account a variety of execution venues providing liquidity as part of their best execution obligations, which includes FBAs. 

AFME believes it is too early to assess the overall impact of MiFID II on the execution landscape. Therefore, AFME is of the view that regulatory amendments at this stage may be premature, including with respect to FBAs, which remain small in terms of market share. Importantly, given the market has seen only one full cycle of the DVC, AFME recommends that ESMA continue to monitor trading patterns for a longer period before seeking adjustments on a mechanism that has provided an additive and beneficial source of liquidity to European end investors.

In accordance with the Better Regulation process, and before ESMA proposes any changes to existing regulation or guidance, we expect further consultation and dialogue with ESMA on this matter. Additionally, we respectfully request ESMA to consider carefully the benefits that a variety of complementary liquidity pools and execution choices bring to European end investors.  

Full AFME response

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Nasdaq

A key objective of MiFID II/MiFIR is to increase transparency in the European financial market. This objective is intended to be achieved, in part, through the ban on broker crossing networks (BCNs) and the double volume cap (DVC) introduced on dark equity trading. However, following application of MiFID II/MiFIR, market analyses show that volumes previously traded in the dark have only to a limited extent moved to lit venues and that the main shift has been to systematic internalisers, block or large in scale venues and periodic auctions. For periodic auctions, the rise in market share has been attributed to these not being covered by the DVC which has applied since 12 March 2018.

However, as mentioned in ESMA’s paper, trading venues operating auctions is nothing new, on the contrary, auctions are widely used to open and close trading sessions in an orderly manner, and many venues also organise intra-day auctions, including frequent batch auctions.

While Nasdaq recognises many of the observations in ESMA’s analysis of frequent batch auctions, it is of the opinion that the development of volumes is not a major threat to price formation and does not violate the spirit of MiFID II.

Nasdaq would urge ESMA and the NCAs to prioritise further investigations and analyses of the market structure as a whole, as it has developed after the implementation of MiFID II. Far bigger increases of volumes than in the frequent batch auctions have been observed in systematic internalisers for instance, which seem to capture ca 25-30% of total volumes. Any consideration of regulatory measures need to be based on a thorough analysis of the overall market structure.

Nasdaq also welcomes ESMA continuing its work on converging implementation of EU rules, not least in the field of market structure, including on periodic auctions. As new trading patterns emerge and develop, it is crucial that supervisors across concerned markets can take a harmonised approach in order to maintain a level playing field. One example where there in particular seems to be room for further convergence, is whether off-tick midpoint matching shall be allowed in frequent batch auctions, or not. This issue is important enough to impact incentives on where to seek execution. The example highlights the need for a swift mechanism among supervisors to address diverging supervisory approaches, within the EU as well as with authorities and stakeholders in third countries where equivalence decisions are in place, or may be implemented in the future. This is particularly important in relation to third countries where there is a high degree of interlinkage between markets.

Full Nasdaq response

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LSEG

Dark Trading and FBA Correlation. LSEG acknowledges the link which the data suggests between trading under volume caps and using FBAs. However, it notes that frequent batch auctions are still a tiny part of the market, as demonstrated by the data which ESMA reports in the CP 0.5% in Jan 2018 rising to 2.3% in Aug 2018

Best Execution. FBAs offer a new execution channel for participants to meet their best execution requirements, which is an integral part of MiFID II. Some academic experts argue that FBAs provide a potential solution to latency arbitrage due to the discrete-time matching mechanism, complemented by a random end time, provides improved execution analytics and this is demonstrable with data from independent analytics providers which shows that with continuous matching this can cause the price to move immediately after the trade takes place. Best execution is optimised when price formulation is maximised (and potentially undermined if there is zero price formulation).

Auction Duration. Auctions are typically characterised by containing an auction call period prior to an uncrossing event. LSEG does not think that the regulator should determine a minimum length of time for the periodic auction but it thinks that the features of the auction should be determined by the trading venue in order to allow to its members concrete possibility to interact.

Self-Matching. Turquoise data shows an extremely low amount of self-matching (0.02% of trades are self-matching of orders of the same size arriving within the 100ms, the maximum duration of an auction call period). FBAs are still in the adoption phase, looking to drive more participation and an active pipeline of players looking to join which we expect will reduce the level of self-matching. LSEG notes that ESMA seem comfortable with self matching on order books and order priority functionality that seeks to increase the possibility of self-matching based on long-standing functionality of certain Central Limit Order Books or other trading systems, and it is unclear why there is therefore extensive focus on FBA mechanisms in this regard.

Full LSEG response

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AIMA

AIMA and its members support the goal of MiFID2 to increase the level of transparency in secondary markets in Europe, whilst fostering the move to multilateral trading across a range of asset classes. However, it also believes that this drive should not come at the expense of choice in respect of execution methodologies or stifle innovation.

In this regard, it notes that it is broadly supportive of periodic auctions (“PAs”), including frequent batch auctions (“FBAs”), because they reduce both implicit costs and explicit costs to investors.

AIMA research shows that intra-spread trading generally, and PAs in particular, are beneficial to the market and save money for investors.  It believes this is supported by the continued usage of these techniques by buy-side market professionals in the context of their pursuit of best execution and endeavours to maximize returns for investors following the implementation of the recast Markets in Financial Instruments Directive.

AIMA is not aware of any quantitative evidence that PAs have adversely affected quote stability, price volatility or market quality, and note that they constitute a very small proportion of European equities trading. It would therefore strongly oppose any proposal to limit the availability of such auctions because we believe this would cause significant harm to investors’ interests and impair firms’ ability to discharge their duties of best execution.

AIMA also believes that competition between multiple execution venues and models, and the different means of accessing liquidity these present, is beneficial to investors and contributes to market integrity by reducing costs, improving price formation and discovery and diversifying risk across the financial system.

To the extent that ESMA does identify that an individual venue is structuring PAs in a manner that is intended to circumvent MiFID2 transparency provisions, supervisory action in respect of that trading venue would be warranted; however, AIMA cautions against any approach that assumes that all PAs are identical in their parameters or that seeks to impose change on systems that are not in any way breaching rules.

Full AIMA response

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Call for evidence

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