The closing auction has increasingly become a dominant liquidity event, driven by both passive and growing active participation, however mounting challenges of market fragmentation and the rise of off-exchange trading pose potential obstacles for market participants trading at the close.
Speaking at TradeTech in Amsterdam this week, experts across the buy-side, sell-side and exchanges highlighted how for European markets, fragmentation and transparency serve as a double-edged sword, presenting both opportunities, as well as complexities for market participants, such as assessing the true closing volume and price.
As mentioned in the panel, the closing auction has become an integral part of the trading day, with Bertil Meijer, senior trader at Cardano, commenting: “In an ideal world, I would trade everything at the close. But my point is, if a broker has already found an offer and passed it along, why does he need to pay twice the cost?
Often, orders on the closing auction are often placed as late as 4pm CET, and close liquidity sometimes representing up to 67% of daily liquidity in this compressed trading window, according to experts.
This, of course, makes trading on the close attractive, however challenges in Europe, such as variances in brokerage strategies, costs and operational risks sometimes complicates this.
Speaking to this, Meijer said: “To clarify, the explicit cost is mainly operational risk. When you consider the complex access gateways and AMUs across Europe, from Italy to Amsterdam and beyond, the potential for something to go wrong is very high. So, operational risk and explicit costs are the primary drivers for alternative offerings. However, I don’t believe we’re in immediate danger of breaking the mechanics, as long as the imbalance flows to the primary exchange. Price formation is still intact.”
Read more – Market volatility fuelling opportunities for on-exchange and closing auction trading, experts concur
Reflecting on this, fragmentation in Europe can often make it difficult to measure liquidity accurately at the close, and impacts the markets’ ability to address these issues effectively.
“Even just determining the denominator at the close is incredibly difficult because so much of the liquidity isn’t printed at all,” asserted Rob Cranston, head equity business development sales strategy at SIX.
“There’s a significant liquidity gap, and it’s challenging to get an accurate picture due to the fragmentation. The closing auction is highly fragmented, and to get a clear view, participants need to access multiple venues to tap into all the different liquidity pools.
“But for me, if you can accurately identify the denominator and understand its size, you’re in a better position to help regulators address the issue and make meaningful changes going forward.”
Maintaining integrity at the close
When thinking about how to maintain the closing auction’s integrity amid evolving market structures, panel discussions emphasised the importance of embracing innovation and thinking of new ways to offset risks from fragmentations and internal crossings.
Cranston highlighted that some exchanges have already taken steps in this direction, noting: “From our side we’re thinking a lot about how do you incentivise, and look at this to encourage earlier price formation, and transparency, and put that into the market.”
Read more – Continued decline in lit volumes sees closing auctions and dark pools become more prevalent
Despite this, vigilance and careful design to maintain confidence in the closing price remains key, particularly as the industry speeds up.
“All parts of the financial industries, are being confronted with the race to zero – in commissions, fees, regulatory and data costs. Ultimately, all these things play into how we implement our flow,” said Meijer.
“For the buy-side, we see that it’s hard for brokers to compete with very large banks that have big design programs and can internalise between 30 to 60% of their flow. So the race to the bottom is forcing us to look past which programs can give us the same price at a lower cost.”
Hence, upon reflection, as European markets grapple with fragmentation and cost pressures, fostering innovation and maintaining transparency appears to be a critical tool for the closing auction, and will help support its integral position within these markets going forward.