European Securities and Markets Authority Publishes Final Report on Frequent Batch Auctions

The European Securities and Markets Authority has published a final report presenting the feedback to its November 2018 call for evidence, which sought to improve its understanding of "frequent batch" auction systems and their use in the circumvention of the "double volume cap" imposed under the Markets in Financial Instruments Regulation and transparency requirements under the revised Markets in Financial Instruments Directive (or MiFID II). ESMA intends to produce further guidance on areas highlighted in the report, particularly focusing on price determination and pre-trade transparency, and will review the broader effects of the MiFID II transparency regime.
 
"Frequent batch" auctions are a method of trading shares. They operate in a similar way to conventional auctions, in that the auction platform receives offers from investors wishing to buy shares at or below a maximum price, and from those wishing to sell shares at or above a minimum price. The auction platform collects these offers, often over the course of a day, and determines a single price that maximizes the trades that can be carried out at the same price. The auction platform then periodically triggers a "call period" each time a buy and sell order can be matched and traded. During the call period, other participants can submit their own buy and sell orders into the auction. Call periods typically last just a fraction of a second. The prevalence of frequent batch auctions previously made up a tiny percentage of the market, but has been increasing since MiFID II came into force.
 
Regulators have become aware that such auctions may be being used to circumvent the "double volume cap". The DVC is a measure imposed under MiFIR to reduce "dark trading", in which the price and quantity of shares to be traded are not disclosed to the market by market operators and trading venues prior to execution. The cap means that dark trading in a certain share can be suspended for six months if the volume of dark trading exceeds certain thresholds. It was introduced as part of the aim to improve the transparency of financial markets.
 
The Final Report is based on feedback to ESMA's call for evidence from 33 respondents, including trading venues, market participants trading on frequent batch auctions and major trade associations and industry bodies. The call for evidence asked respondents to consider four key issues around frequent batch auctions: (i) limited pre-trade transparency; (ii) short auction duration; (iii) price determination with the best bid and offer price; and (iv) self-matching features (which enable two orders from the same trading venue member to be matched), as well as the use of frequent batch auctions to circumvent the double volume cap and MiFID II transparency requirements.
 
The Report considers the responses received to the call for evidence on each of these areas and sets out ESMA's conclusions on each topic and the actions it proposed to take. More than half of the respondents agreed that there was a correlation between the increase in frequent batch auctions and the circumvention of the DVC, but most also cited other reasons behind the rise in frequent batch auctions, including the enhanced possibility of executing trades within the best bid offer spread, lower price movements of these auctions and low information leakage. While ESMA agreed with the responses, it did consider that some of the reasons proposed still raised questions over transparency. ESMA intends to take action to tackle these areas, including: (i) issuing further guidance on the level of information that trading venues should provide to market participants regarding the commencement of an auction; (ii) monitoring the use of frequent batch auction systems to prevent some price determination practices and issuing guidance to clarify ESMA's position on price determination practices in general; and (iii) issuing guidance on the acceptable use of self-matching.
 
View ESMA's Final Report.
 
View ESMA's Call for evidence.
 
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