Han Gulyàs, a PhD Candidate at Radboud University was a Junior Academic Visitor to the CLC in Michaelmas term, 2018

On 3 January 2018 the MiFID II-regime (hereafter: MiFID II) entered into force. One of the main objectives of MiFID II is to enhance transparency in the European equities markets. An important element of this ambition are the MiFID II pre-trade transparency-rules. Pre-trade transparency refers to the extent of information that is displayed to investors about current trading opportunities, such as prices and volumes. Over the years trading in financial instruments, in particular equities, has migrated to electronic platforms that display pre-trade transparency. Following the greater transparency, investors under MiFID I (i.e. the predecessor of MiFID II) used several tools to hide their trading intentions, such as by trading in so-called dark pools. As a reaction to the growth in dark trading under MiFID I, MiFID II tightened the European pre-trade transparency rules. Now, almost a year after the implementation of MiFID II, it is time for some early reflections on its desired effects. One thing that stands out is the increase in so-called periodic auctions post-MiFID II. The main question is whether this increase can be explained as a new method to circumvent the stricter MiFID II pre-trade transparency rules, or instead, that other factors play a role.

To approach this question we need to step back for a moment and explore what a periodic auction constitutes. A periodic auction refers to a system in which orders (an instruction to buy or sell a financial instrument) are matched periodically by means of a trading algorithm. A variety of periodic auction models exist. A common approach is to collect trading interest throughout the day, where a ‘call period’ is triggered every time two opposing orders can be matched (i.e. there is a buy and sell order, where the selling price is not higher than the buying price). When two opposing orders can be matched, the algorithm determines a single ‘uncrossing’ price. The single uncrossing price is displayed to other investors. The other investors can then decide to submit their own buy and sell orders into the periodic auction at the displayed single uncrossing price. What sets periodic auctions apart from more common central limit order books (CLOBs), is that CLOBs are continuous. A buy order in a CLOB will immediately execute at a matching sell order resting in the system. Instead, in a periodic auction investors have to wait until the end of the call period.

Some argue that the rapid rise in periodic auctions post-MiFID II is because periodic auctions display pre-trade information at a later stage than continuous systems. Periodic auctions only publish pre-trade information once a single uncrossing price is set following two opposing orders (buy and sell orders are matched) and not at the initiation of the auction, that is – upon receipt of the first order (a buy or sell order enters the system). The mechanism of periodic auctions therewith contrasts with continuous systems where pre-trade information is published at the moment an order is entered into the continuous system. Periodic auctions could therefore be a loophole to circumvent the MiFID II pre-trade transparency obligations. This could harm the MiFID II objective to enhance transparency in the European equity markets.

The rise in periodic auctions could also be explained by other factors than a lower level of pre-trade transparency. For example, another benefit of periodic auctions is that they reduce the importance of speed and latency in trading compared to continuous systems. If in a continuous system an order arrives later than that of another investor, the first investor has priority in terms of trading. This could result in the later order not being executed, or at a worse price. In times where some investors have access to extremely fast trading technology (e.g. high-frequency traders) and others do not, periodic auctions could level the playing field between investors. Hence, the search for protection against fast traders could also be an explanation why periodic auctions have grown post-MiFID II.  

The jury is still out on what drives the post-MiFID II increase in periodic auctions. Research conducted by the UK Financial Conduct Authority (FCA) suggests that at first sight periodic auctions are not used to circumvent the MiFID II pre-trade transparency rules. ‘At first sight’, because the FCA notes that further analysis on this matter is necessary, given that MiFID II is still in its early stages. Aligned with this thought the EU’s securities watchdog, the European Securities Markets Authority (ESMA), has issued a call for evidence on periodic auctions. The call for evidence closes on 11 January 2019 and will take some time for ESMA to evaluate. Therefore, only time will tell whether ESMA considers it necessary to address periodic auctions. In my dissertation (expected in 2020) the matter of periodic auctions, including ESMA’s final position, will be examined. The dissertation explores transparent trading in the European equity markets over the past three decades, including the rise in periodic auctions under MiFID II.