[ I N - D E P T H
|
C L O S I N G
founder of Aquis Exchange, one
of the market operators that has
introduced an alternative closing
auction mechanism in Europe,
also points to other trends in
the market that have caused the
percentage of volumes to move so
dramatically from continuous trad-
ing to closing auctions, although he
argues it remains unclear exactly
what has driven the trend.
“The problem is nobody out there
can actually tell you whether this
trend is structural or cyclical,”
Haynes says. “What we do know
is that more business is being
conducted in the close than ever
in the past, and to a level where-
by it is getting significant and, in
some ways, the trend is probably
not healthy for the market. Is this
passive trading which demands
the closing price? Frankly, I don’t
buy that argument. I believe it is
a combination of different things,
some which are structural and
some which are cyclical.”
The cyclical part which Haynes
refers to is a clear reduction in total
volumes across the European eq-
uities trading landscape this year,
including in the closing auctions,
as a seemingly relentless risk-off
sentiment continues to dominate
the market. David Howson, chief
operating officer at Cboe Europe,
which has also launched an alter-
native closing auction mechanism,
adds that the combination of low
volumes, volatility and the rise
of passive investing has made it
challenging for traders to execute
during the day, particularly larger
sized trades.
“Over the past 12 months, the
risk-off environment that markets
have endured due to uncertainties
around Brexit and trade wars has
caused volumes and volatility to
decline, creating much thinner
markets intraday on the lit books,”
Howson comments. “That leaves
52 // TheTrade // Winter 2019
A U C T I O N S ]
“It has led to thinner volumes during continuous
trading and increased intraday volatility, which
is bad news as it precipitates an instable market
because price formation is unreliable.”
DANIEL NICHOLLS, HEAD OF TRADING, HERMES INVESTMENT MANAGEMENT
less room to transact large posi-
tions intraday, which means more
participants turn to alternative
mechanisms and ultimately closing
auctions to execute their trades.”
Liquidity begets liquidity
As the volume profile of the
market has changed, so have the
volume-profiling algorithms. The
volume-weighted average price
(VWAP) algorithm, for example,
maps distribution of liquidity
throughout the day to an order,
meaning as volumes in the closing
auction increase, the more the
algorithm will route orders there.
Essentially then, algorithmic
trading is accelerating the shift to
the close. As the concentration of
liquidity and volumes in closing
auctions has become more promi-
nent, buy-side traders have adapted
strategies as intraday liquidity has
become harder to find.
“This has been an important for
us because we have been adapt-
ing to it quite recently,” says Eric
Champenois, head of the trading
desk at asset manager Unigestion.
“There is not much volume in the
morning now, so we tend to be
more passive during that period
than previously and our volume
participation during these hours
has been impacted. It’s mostly a
negative development for investors
because for at least fifty percent of
the trading day it’s difficult to find
proper liquidity.”
It’s a case of liquidity begets
liquidity. As volumes are forced
to the end of the day, the closing
auctions are fast becoming the only
place to execute in size in the mar-
ket today. When news or informa-
tion comes out, it’s important that
traders have the ability to engage
in continuous trading, but as the
buy-side struggles to interact with
intraday liquidity, the market has
had to hold positions to trade at
the close, which is not considered
to be a positive development for
investors. The ability to offload
risk throughout the day is consid-
ered a strong sign that a market is
well-functioning.
Hermes’ Nicholls echoes Champ-
enois, adding that the migration
of volumes to the close is even
more problematic for traders that
have different benchmarks due
to subscriptions and redemp-
tions in the fund. If money hits
a fund, a trader will be looking
to transfer the money into
equities as soon as possible.
Traders can’t sit on an order
for an entire day before placing
it in the closing auction, and
even then, they risk losing out
altogether due to the uncertainty
of execution and price at the end
of the day.
“When money arrives into the
fund it hits at different times
of the day, the trader has
to aim to transfer that
money into the price of
equities at that time to
minimise slippage,”
Nicholls says. “The
prices in the clos-
ing auction can be
wildly different,