What Next for Periodics?
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ESMA has now published its views on the future of periodic auctions and the steps it intends to take based on the call for evidence issued in November 2018. As we noted in Liquidity Landscape, rather than ruling Periodics out in their entirety, ESMA is looking for greater consistency and clarity over auction constructs to ensure that these are not being used to circumvent the Double Volume Cap (DVC). This is good news for the buy-side as Periodics have become a valuable construct in minimising market impact and thereby reducing unnecessary execution costs - but the question is the extent to which ESMA now plans to restrict activity.
The perceived lack of pre-trade transparency and price discovery in certain types of Periodics– Frequent Batch Auctions (FBA) rather than conventional periodic auctions – is where ESMA is focusing their attention. FBAs often have a shorter duration of milliseconds and can be triggered sporadically rather than being scheduled by a trading venue; and secondly, in relation to price formation, the use of EBBO price collars and pegged orders can – in ESMA’s opinion constrain full true price formation. The challenge for the industry is that the use of price collars facilitates trades being executed at current price levels; those brokers who have restructured dark strategies to Periodics to minimise execution risk will now need to re-consider routing mechanisms as a result.
While MiFID II may have had the intention of increasing transparency, it is clear that this has not been achieved to the extent required, and the DVC has moved trading to Periodic auctions and OTC (SIs) rather than increased lit trading in the EU. If the regulators want to see further support of continuous lit trading, ESMA will need to continue to seek alternative means of changing market behaviour and we can expect further regulatory changes until these objectives are met; changes to Sis are likely to be next.
Rebecca Healey, Charlotte Decuyper, and Lara Jacobs, EMEA Market Structure + Strategy