Reforming The Open And Closing Auctions
With Anthony Godonis, Senior Equity Trader, Aberdeen Asset Management
When considering open and closing auctions, the bottom line is it that current procedures are reliant on listings. It has more to do with which exchange has the most listings, and whoever has the most can run an auction – so it’s primarily New York and NASDAQ that we are concerned with.
In terms of how the auctions operate, there are indications put in by traders onto the open and close. The majority of people in my position focus on the order balance (the ratio of buyers to sellers). If there’s an imbalance on the buyer and seller side, it gives you an idea of whether the given stock is going to open up or down, but there’s not much indication of what price it will actually do so at.
If there were more transparency in terms of pricing and number of shares on the open and close, more people on the buy-side would be willing to trade. However, I don’t feel institutions like participating on the open and close because it’s too easy for other market participants to figure out your level of interest, whether they are high frequency or other institutional firms.
The close requires that are orders to be entered by a certain time, but it can be difficult to get out of the closing auction. This is because we have to perform a ‘de-quote’, requiring the broker to call someone in New York to get the order pulled out of the auction.
Considering we are part of the most advanced financial ecosystem in the world, this is still a manual and outdated operation. It should be possible to do it much more quickly.
So we need further development in terms of transparency around the available size and price. Consider the volume – 30-50% of a stock’s volume is done at the open and close – in our view that volume should be a driving factor. The main force behind much of the open and close procedure is ‘passive money’; for these firms, much of their trading typically takes place at the close as traditionally they benchmark to the close. It’s a reference price – there is less thought given to individual stock performance and more towards capturing that closing price. And as so much money has moved from ‘active’ to ‘passive’, there has been very little discussion about the open and close because the active traders (myself and my peers) don’t particularly feel price formation is disseminated efficiently.
There should be far better dissemination of information for New York and NASDAQ and it would help if we could see what the auction looks like on a screen on a real time basis.
The open and close process has become overcomplicated. For example, where specific order types focus on the opening auction. On paper this may look very simple but when we really look into it, participants may be able to abuse the system simply due to the complicated nature of the structure. So it is clear that the open and close needs to be simplified. If it were, it would certainly be a catalyst for more traders wanting to participate.
It will be a challenge to standardise the open and close procedure. The only way to completely standardise is to force the auction to take place in one particular location; which would be difficult considering the volume and amount of revenue they generate for the exchanges. In the meantime what would help would be a greater effort to standardise across those exchanges that have auctions.
This leads to the question what is the role of an exchange? An exchange is supposed to be, fundamentally, an auction. An auction is a group of people who get together to determine the best price of an asset which someone is willing to clear. What is the clearing price? The sellers want to sell at the highest price. The buyers want to buy at the lowest price and where the two meet is the clearing price. The complexity of the current system means that it doesn’t feel like an auction house anymore.
To summarise, the process of open and closing auctions needs to be simplified. I believe the asset owners should be given more control of the open and closing prices, as opposed to the market makers. The market makers are there to provide liquidity, but they aren’t in the business to lose money either, so it is primarily a profit centre for the market makers. The market makers seem to be more in control of market structure and how things work than the asset owners. I would also say that the buy-side should be reaching out to the regulators as well as exchanges, establishing relationships with them and trying to figure out a better way of working. But until that happens, I don’t think much is going to change.
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