Little evidence of closing auctions deteriorating price formation, says AMF

Activity in closing auctions has surged across Europe, but a study from France’s AMF says the concentration of volumes at the end of the day has not affected price formation.

The surge in trading activity occurring at the end of the day in closing auctions in recent years has not deteriorated the price formation process, according to France’s financial watchdog.

The Autorité des Marchés Financiers (AMF) conducted a study after stating earlier this year that a concentration in volumes at the end of the trading day could undermine price formation due to declining liquidity during the trading day. The study, however, did not find an increase in drastic price swings, which the regulator said would have been a clear sign of a deterioration in price formation.

Volumes of shares traded in closing auctions has steadily increased from between 20% and 28% through to 2015, to 41% traded on Euronext Paris for CAC 40 stocks as of June this year. Reasons for the surge in end-of-day trading activity include the growth in passive investment, MiFID II’s best execution requirements, and the desire to avoid high-frequency traders who do not usually engage in trading during closing auctions.

A report from TABB Group published earlier this year claimed that closing auctions now account for as much as 25% of a stock’s average daily trading volume in Europe, compared to around 8% in the US. TABB Group described the trend as self-perpetuating and arguably the industry’s biggest ‘catch-22’, as the more activity that occurs at the close, the more volume-driven algorithms route orders there.

“Closing auctions, by their nature, work best as a centralised process, meaning there is no desire for competing, price-forming closing auctions. However, that hands significant pricing power to the primary exchanges that run auctions and makes them a single point of failure,” the report stated.

Senior buy-siders and heads of desks at European asset management firms said in the report that closing auctions are a largely positive development for the industry, although some expressed concerns from a market structure point of view.

The high fees charged during the closing auction periods was listed as the primary concern, followed by the trend’s impact on liquidity during the day, which many buy-side respondents told TABB Group had thinned out considerably. Eighty percent also agreed that the increase in volatility between the last traded price and the closing price makes it more difficult to predict prices in the auction.

“There is a lot of liquidity in a limited amount of time, and we just don’t know what the price is going to be. We use mainly limit orders in the auction, and because market orders take priority, we often find we miss out on liquidity,” one head of multi-asset trading at a European buy-side firm told TABB Group.

AMF’s study also identified increased operational risks for traders engaging with closing auctions, referring to one incident in May 2018 whereby a trader wanted to execute a buy/sell-back transaction on 3.5 million shares, but triggered Euronext’s circuit breaker. The trader tried to reduce the size to 2 million shares, although only had time to enter the buy order. The error resulted in a €2.2 million loss, with multiple market participants impacted by the event.

“The risks identified above are monitored permanently by the AMF. In particular, the AMF’s real-time supervision tools can detect a potential major ‘flash crash’ during the session. Since 2016, however, the AMF has not identified an increase in the number of drastic fluctuations, which means that, at this stage, it is not possible to conclude that there has been a definite deterioration of the price formation process,” the regulator concluded in its report.