18.III.3.3.4 Growth in frequent batch auctions

Despite the ambitions of MiFID II, market participants have continued to use technology in order to create new dark trading possibilities. A main technical innovation is the growth in specific periodic auctions, being frequent batch auctions. Although periodic auctions already existed under the ISD and MiFID I, ‘frequent batch auctions’ have gained popularity since MiFID II. To understand what frequent batch auctions are, it is useful to take one step back and to examine periodic auctions. Periodic auctions can be distinguished in (a) conventional periodic auctions; and (b) frequent batch auctions.1 Both auctions have in common that they constitute a system that matches orders on the basis of a periodic auction and trading algorithm. A distinguishing feature is that conventional periodic auctions last several minutes, while frequent batch auctions have a shorter duration of only some milliseconds. Another difference is that conventional periodic auctions are scheduled by an RM or MTF, whereas frequent batch auctions are either triggered as soon as an order is submitted, or once a potential match has been identified.2

A debate is taking place as to what explains the rise in frequent batch auctions. On the one hand, it can be argued that frequent batch auctions create a speed bump against high frequency traders. This is because supply and demand in frequent batch auctions are not immediately matched, which contrasts with, for example, continuous order-driven markets of RMs and MTFs.3 On the other hand, there are concerns that the rise of frequent batch auctions is driven by the aim to reduce pre-trade transparency. Not all, but certain frequent batch auctions are only initiated when a potential match has been identified. This means that pending the identification of a potential match, no pre-trade data about the pending orders is disclosed. Only once a potential match has been identified, an auction is initiated, and the system discloses real-time pre-trade transparency (unless a MiFID II waiver is applicable).4 Another concern about limited pre-trade transparency is that frequent batch auctions permit the submission of so-called ‘peg orders’. This means that a reference price can be used (‘pegged’) from another market in order to match at the midpoint.5

ESMA proposes a stricter approach for frequent batch auctions in the MiFID II Review. ESMA argues that a distinct equity pre-trade transparency regime should be created for ‘frequent batch auctions’ that are currently operating under the general MiFID II category of ‘periodic auction’. ESMA believes that the general label periodic auction is better suited for conventional periodic auctions (e.g. open and closing auctions). ESMA believes that a distinct equity pre-trade transparency regime is necessary for frequent batch auctions.6 If the ESMA proposal would be accepted, the result would be a more market-shaping (not: market-led) EU strategy for frequent batch auctions.