In January 2018, one of the most ambitious and wide-ranging financial market regulatory reforms ever conceived was implemented: the Markets in Financial Instruments Directive (MiFID II). MiFID II is a European regulation with significant consequences beyond the EU’s borders. Much has been said about its impacts on research unbundling, onerous regulatory reporting, and the cost of transparency which appears to have benefited certain products such as exchange-traded funds (ETFs). However, one of the biggest themes MiFID II has shown us, is that data and transparency are driving operational changes and efficiency for asset managers.
One of the reasons that London has flourished as a global trading center is its location, or more specifically its time zone advantages for global trading. Trading opens on the London Stock Exchange at 8 a.m. while other investment banks and brokers also open for OTC activity. The Asian stock markets are still open, as are the other EU markets, so a flurry of trading activity occurs right from the start, before usually calming. Things ramp up again when the US markets open in the early afternoon, before meandering towards the closing of session. However, since MiFID II took effect, we’ve seen the emergence of what is known as the “closing auction.”
What is the Closing Auction?
The closing auction allows execution of a trade at the closing price and is widely used across exchanges across the globe. During the closing auction, traders who wish to trade at the closing price may input their buy and sell orders. These orders interact with one another and by way of supply and demand form a consensus closing price for each security. The orders placed are then executed at that consensus price. Closing auctions have always been vital to market liquidity since the larger volume of orders make it easier for large trade orders to find buyers or sellers.
Thanks to the continued growth of passive and exchange-traded strategies in Europe (which Morningstar estimates to reach €1 trillion in 2020), the closing auction, a window of just five minutes at the end of each trading day, has exploded in volume – largely due to MiFID II. Passive investors rely on closing price to track their specific benchmarks. According to CNBC, the European closing auction now represents more than 20% of total daily volumes compared to just 13% pre-MiFID II. French regulator Authorité des Marchés Financiers (AMF) said closing auctions now represent 40% of all transactions on Euronext Paris.
This end-of-day convergence comes as a welcome development to some asset managers, many of whom feel it brings about a dependable liquidity pool which can aid in matching buyers and sellers. However, others complain that the execution venues have used this convergence period to charge higher premium prices for access to the closing auction making trading more expensive than other times in the day.
Why This Matters
One of the biggest operational burdens for asset managers under MiFID II has been transaction reporting. This trade reporting has both pre- and post-trade requirements, including reporting detailed information in a timely and accurate manner for all in-scope trades. Interestingly, MiFID II’s best execution clause and regulatory reporting requirements are less onerous on traders who use the closing auction rather than the continuous trading sessions.
Before MiFID II, there was no view into how much trading in Europe was conducted during the closing auction. Transparent trade reporting has brought to light two key unintended gains for asset management:
1. Asset managers now have access to a much larger pool of trading data which can be used to increase the efficiency of their operational processes
2. MiFID II cost and charge transparency, as well as empirical evidence of the depth of liquidity available in the ETF space, has seen an evident increase in EU ETFs, a trend that seems likely to continue.
As we have already highlighted, it is the elevated interest in passive funds and ETFs that is primarily driving the large increase in closing auction trading volumes in Europe, another unintended consequence of MiFID II.
Using these newly available large data pools is increasingly important within asset management as more and more managers are harnessing the power of data. They’re using machine learning and artificial intelligence to decipher big data in order to increase their returns or streamline their operational processes. This closing auction trading peculiarity is a small example of a much broader theme across the asset management landscape.