John, can you explain the growth of periodic auctions in Europe’s equity market and why they are so popular with investors?
Periodic auctions first emerged as a trading mechanism for European equities ahead of the introduction of Mifid II in 2018, with Cboe the first mover by launching its venue in 2015. There was industry demand for an alternative, low-impact execution mechanism given the restrictions Mifid II was placing on other trading modalities, including dark venues and broker crossing networks. Since then, periodic auctions have been steadily adopted by market participants. As a venue grouping they now regularly account for more than 4% of on-exchange activity on a monthly basis – and reached a peak of 5.6% of continuous on-exchange activity during May 2022. Cboe operates the largest periodic auction in European equities, accounting for around 80% of total activity. While Mifid II was the catalyst for the uptick in periodic auction activity, they have been growing as an accepted market mechanism independently of restrictions on dark venues. For example, periodic auction usage has grown for UK stocks even since the FCA’s decision to remove its caps on dark venues in early 2021 – especially in small and mid-cap where liquidity is thinner.
The mechanism has proved popular because it helps investors to minimise the price impact experienced by their orders, disincentivises speed by prioritising order size and introducing randomness in trade timing, and allows for the possibility of price improvement. The dis-continuous nature of periodic auctions, which are ~4,000 times slower than continuous order books, precludes latency-sensitive trading, and results in executions with much more stable post-trade price-path than is common in continuous trading mechanisms. The pre-trade transparency regime applicable to all auctions (publishing the equilibrium volume and price, but not any imbalance information) is less likely to cause price-impact than a lit book in which all bids/offers are made public, whilst being sufficient to attract additional order flow into an auction and thereby enable efficient price formation.
Ben, how can you make use of market data produced by periodic auctions?
As John noted, market data from periodic auctions communicates the availability of liquidity and the opportunity to trade – often at prices within the European Best Bid and Offer (EBBO) spread. Integrating that market data into our algorithms, for a variety of different sub-tactics, allows us to respond to liquidity opportunities for the benefit of our clients. A periodic auction indicating a forthcoming match becomes a materially more likely source of liquidity, in the short term, than other venues, hence our models respond in milliseconds to maximise our chances of participation. We have found a diverse range of uses for these opportunities across our stack, and they score highly on our range of venue metrics.
Laetitia, how do you see the regulatory landscape for periodic auctions evolving, and what are your expectations for their use in the future?
I think we’re at a point now where both buy-side and sell-side participants in Europe’s equity markets have come to regard periodic auctions as a well-established and high-quality trading environment, one that helps to deliver better execution outcomes for end investors whilst providing sufficient pre-trade transparency to support efficient price formation. This is an outcome we have clearly been able to quantify in the implementation of frequent batch auctions in our execution algorithms suite.
The regulatory environment has also stabilised, with ESMA not recommending further amendments to the pre-trade transparency requirements for EU-based periodic auctions as part of its review of RTS 1, published in March. There was strong feedback across buy and sell side respondents to its preceding consultation that the potential changes ESMA contemplated could have seriously impacted the usefulness of these systems. Increasing transparency requirements in periodic auctions – which run in parallel to continuous trading – would have exposed clients to potential exploitation of their activity. Such a change would have rendered Frequent Batch Auctions less efficient in delivering better execution. In a worst-case scenario, it could even have encouraged non-EU participants to favour execution away from EU venues. What was even more encouraging was ESMA’s recognition of the benefits, in terms of market impact reduction and execution quality, that these mechanisms deliver to institutional investors, particularly those less well-equipped to execute in low latency continuous environments.
When combined with the potential restrictions to other trading mechanisms under the EU’s review of Mifid II, we believe this sets the stage for continued growth in periodic auction activity as venues look to innovate and enhance their models and clients further optimise their interactions.
Natan, what is Cboe’s new ‘Accept-or-Cancel (AOC)’ order type and what will it allow participants to achieve in periodic auctions that they couldn’t previously?
Cboe added additional functionality to its periodic auctions in May, with the introduction of the Accept or Cancel (AOC) order type. AOC orders are evaluated upon receipt and are only accepted (and converted into a Good For Auction order) if there’s already a resting contra in the periodic auction and an execution is expected. Otherwise, they are immediately rejected, allowing the broker to move on to accessing other mechanisms. This order type allows brokers to utilise periodic auctions for urgent liquidity-taking flow, searching the venues for liquidity prior to crossing the spread in lit markets. There are optional flags for price improvement (vs. the EBBO, or vs. the order limit price) and support for Minimum Acceptable Quantity (MAQ), meaning that brokers can elect to rest in our periodic auction only if the combination of expected size and price outweighs the risk of waiting (on average 50ms) for an auction to complete before accessing the lit market.
The AOC order type also allows periodic auctions to be used to capture passive liquidity. For every AOC order seeking far-touch (or just inside) liquidity in a periodic auction, there’s an opportunity to provide liquidity and capture the spread. Cboe offers a ‘Near-Touch’ peg order with an ‘Aggressive Offset’ – so we try to make it easy for brokers to rest at the near-touch or one-tick inside to capture liquidity from spread-crossing AOC flow. In summary, we believe this will help Cboe’s periodic auctions support a wider range of trading strategies, to the benefit of end investors.
Natan, lastly, are periodic auctions just a European concept – or can they be replicated in other regions?
While the introduction of the EU’s MiFID II in 2018 was the initial catalyst for Cboe to launch periodic auctions in Europe, the model’s fundamental characteristics – of eliminating speed as a competitive dynamic and prioritising order size rather than time – are attractive to investors in any region. To that end, Cboe launched periodic auctions on its US equities exchange, Cboe BYX, in April 2022. The model, which has been adapted for the nuances of the US market, generates price forming auctions for investors seeking liquidity, including but not limited to block size transactions, during the course of the trading day. These intraday auctions are particularly useful tool to attract buyers and sellers in less liquid or wider spread names. Volumes are growing steadily each week and we have already seen executions that have been in the top five largest prints of the day, including in some illiquid securities. We think it is a model that could be introduced into other regions, including Canada and Asia-Pacific, and Cboe is uniquely positioned to effect that given its presence in all key equity markets around the world.
We want to our successful services to be replicated around the world where possible and give our global customers a uniformity of service whilst adhering to local nuances and regulations.