LONDON (Reuters) – The last five minutes of trading have become the busiest time of day for stock traders in Europe.
FILE PHOTO: The DAX chart of the German stock index is shown on the Frankfurt Stock Exchange on August 1
Apart from a first burst of activity after the morning's opening, followed by Short after the opening of Wall Street, a growing portion of daily stock is now focusing on the five-minute closing auctions at the end of the day.
The growing popularity of passive funds and funds with index tracking, as well as tightening regulations, is causing a shift that is weighing on liquidity in the $ 11.1 trillion market, raising concerns about large price volatility and possible pricing disruptions.
The trend is also breaking the industry as competitors try to take some of the action by bringing their own post-close trading products to market. If this persists, it is likely to stimulate debate about whether a long trading day is needed in the long term.
Products such as Exchange Traded Funds (ETFs) and hedge funds typically use daily closing prices set for daily prices during closing auctions.
Equity ETFs in Europe have skyrocketed in recent years and now have a value of around 500 billion euros (558 billion US dollars). This is more than 8% in the first half of the year and a whopping 38% as of January 2017, according to Morningstar data.
With its increase, the five-minute window between 1530 and 1535 GMT per day occupies a larger portion of the daily volume June averaged around 70 billion euros.
The closing auctions on the most important European stock exchanges accounted for an average of 20% of the daily average volume in the first half of this year, reaching the highest level in June, at 23%, according to Rosenblatt Securities.
That's an increase of only 13% three years ago. A similar trend can be observed in the USA, where activities are also increasing in the auctions.
Activity typically increases in the last month of each quarter as funds seek to participate in the auctions that determine the value of their investments for the quarter.
However, this year saw a significant and steady increase each month as banks, brokers and asset managers felt the auctions provided the deepest liquidity pool.
"The rest of the day is meaningless and you can not see any power," said Andrea Vismara, managing director of Italian boutique investment bank Equita.
The jump was particularly noticeable this year, as trading volumes slowed due to tighter regulation and rising costs, and investors generally shied away from stocks even though prices rose.
The paperwork imposed by the EU Directive on Markets in Financial Instruments (MiFID II), which entered into force at the beginning of last year, has also helped push the relocation. The reporting process for regulatory purposes is easier when trading is carried out at the closing auction.
The trend has attracted the control of French market regulator Autorite des Marches Financiers (AMF), which warned last month that lower liquidity could distort price-setting mechanisms and increase price volatility.
Closing auctions on Euronext's Paris blue-chip CAC-40 stock index ( ENX.PA .CHCHI accounts for up to 40% of volume.
"The associated risks are a downgrade pricing and liquidity during trading sessions and operational weaknesses at the end of the day given the quantities concentrated in the closing auction, "said the Watchdog in his report.
GRAPHIC: closing auction volume – hier.png
LIQUID BEGINS LIQUID  Whether pricing has been disrupted so far is not clear, but interviews with a dozen traders and executives at international banks, brokers, asset managers and the stock exchanges show that business flows are on the rise.
Liquidity creates liquidity first – if more traffic passes through the closing auction, it has a self-reinforcing effect.
"In many F cases are the volumes in the closing auctions so significant that they can not be ignored, "said Derek McCole, head of equity trading for EMEA at Aberdeen Standard Investments.
He has adapted to the new standard. It tends to place a percentage of an order at the settlement price in the closing auction and then opportunistically trade the remainder of the order when a certain price is reached.
However, some executives say it's harder to make large block trades during the day, forcing many to save big deals by the end of the day. This results in even lower liquidity in the remaining 8-1 / 2 hours.
"The market opens, nothing happens and then the US comes in. He's busy for the first hour and then calms down," said a senior executive at a global bank.
"People are fighting to execute orders. If you are looking for blocks, wait until the final auction.
RARE INCOME SOURCE
For stock exchange operators such as the Deutsche Börse ( DB1Gn.DE ) and the London Stock Exchange ()] LSE.L ), the rise in closing auctions offers a rare one and much needed source of income.
The stock exchanges often charge higher fees for transactions in the closing auction than intraday rates. Each exchange has a different fee structure, making it difficult to determine an exact premium.
However, there is evidence that the financial industry is divided over this trend, and CBOE Europe and Aquis Exchange ( AQX.L ) launch competing platforms to break the monopoly of the stock exchanges.
CBOE claims to charge customers with the use of its 3C product later this year, while Aquis calculates a fixed subscription of £ 10,000.
Alasdair Haynes, Chief Executive of Aquis, said he wanted the Market At Close product of his company to give the stock market a competitive edge. He estimates that auction closing fees cost the industry an additional £ 75 to £ 100 million a year.
The product received British approval several years ago, but in recent weeks the volume has only increased, said a spokeswoman.
This growing interest is due to banks trying to cut costs due to wafer-thin margins that have been undermined by the burden of additional regulation and lower volumes.
"There is no doubt that there is a correlation with banks trying to save money and interest in our product, where banks are making serious cost savings," said Haynes.
But the trip from Aquis and CBOE has again sparked concern about withdrawing liquidity from the main stock exchanges.
"Exchanges are expected to exploit their monopoly position in closing auctions, so the lower fees for alternative products may be attractive to brokers," said Anish Puarr, market structural analyst for Europe at Rosenblatt Securities.
"However, there is a risk of liquidity fragmenting in the auctions," he said.
Investors such as Equita and Aberdeen also fear that alternatives could pull volumes off closing auctions and distort pricing.
"As these different types of closet trading occur, this could potentially weaken the existing closing structure as liquidity moves from the primary market to these other mechanisms," McCole said.
($ 1 = $ 0.8950)
Reporting by Josephine Mason; additional coverage by Simon Jessop in LONDON and Inti Landauro in PARIS; Edited by Hugh Lawson