How Periodic Auctions Enhance Trading in Europe and the U.S.
Periodic Auctions – an alternative and complimentary market model to continuous limit orderbooks – offer frequent short-duration price forming auctions for investors seeking liquidity throughout the course of the trading day.
Cboe® launched Periodic Auctions in Europe in 2015, ahead of the MiFID II regulations which changed equity market structure in the region. Cboe introduced Periodic Auctions in the U.S. in the spring of 2022 to offer an on-exchange model for block-sized liquidity that can compete with various off-exchange solutions. Our North American Execution Consulting Team published a study this year on the growth in off-exchange trading which highlights the benefits of using Periodic Auctions. In this new study, we leverage Cboe’s global footprint to showcase the similarities and differences between Periodic Auctions in both regions, and how the product can assist investors’ execution quality and liquidity sourcing.
Periodic Auctions in Europe
The European regulatory framework mandates simplicity in exchange order types, defining specific pre-trade transparency obligations for different market models. To meet these obligations, Periodic Auctions operate as a discrete service alongside, but independently of, Cboe’s Lit, Midpoint and LIS block trading orderbooks.
In terms of price formation, volume discovery and market transparency, Periodic Auctions are like miniature versions of the Opening/Closing auctions operated by European listings venues. But, with auctions running multiple times a second, they represent a near-continuous market model operating in parallel to the other continuous market mechanisms.
The auction algorithm generates a single clearing price at which the greatest volume will trade and accepts limit, market and pegged orders (including near-touch and midpoint peg instructions, with and without offsets) during an auction call phase that lasts up to 100 milliseconds, with the precise duration subject to randomization.
Orders can be sent with three “time in force” values. DAY orders are accepted and rest in the system until canceled by a user. Good For Auction orders are accepted, but automatically expire at the end of the auction call period, so they have an average lifespan of under 50 milliseconds. Accept-or-Cancel orders are assessed on arrival, based on the price and size parameters of the order on the contra liquidity in the system. Based on these criteria, if they are deemed to be executable, they are accepted and converted into a Good for Auction order.
The Price Formation Process
The clearing price is chosen using a four-step tie-breaker process, with the following criteria assessed in sequence: -
- Maximum executable volume
- Minimum surplus
- Minimum market pressure
- Reference price
In line with the MiFID II transparency framework for auctions, this indicative clearing price and the associated volume is published in real-time throughout the call phase, alerting market participants to an impending auction uncross event, and giving them the opportunity to join the auction. While 100 milliseconds might sound short, in the context of algorithmic trading it is more than sufficient to allow market participants to react to the available liquidity as the indicative price and volume evolve.
However, because the auction indicative prices are published contemporaneously with price formation in lit continuous markets, and all venue operators have responsibilities to maintain an orderly market, a price collar is applied to the mechanism, outside of which the auction will not uncross. In the UK-based exchange that price collar is the European Best Bid or Offer (EBBO), while on the EU-based exchange regulators have insisted the collar be one-tick outside the EBBO.
At the end of the call period, the auction uncrosses, assuming a valid indicative price within the collar and non-zero indicative volume. With the clearing price set, available volume is allocated among orders eligible to trade at that price on the basis of broker-preference (an optional preference to match first versus contra orders from your own firm) and size (preferencing larger orders), while respecting any specified minimum acceptable quantities. The complexity of this allocation process means that the full indicative quantity is not always guaranteed to trade.
A further consideration of operating auctions contemporaneously with other mechanisms - and where execution algorithms must frequently react to quote and trade events across many venues - is that participants generally would want to avoid cancelling an order that is just about to trade, or having a contra cancel an order that they were just about to trade with. In support of this, when Cboe’s Marketable Order Lock feature is enabled, if a user tries to cancel an order which is just about to trade, the system ignores the cancelation request but amends the order’s time-in-force to Good For Auction, meaning that it will expire as soon as the auction ends, typically within 50 milliseconds.
Because the Periodic Auction orderbook is independent of Cboe’s other European order books, there is appetite for sweep orders that sequentially seek liquidity across those books, including a Dark->Periodic sweep and a Dark-on-Expiry option. Earlier this month Cboe added four more Sweep order types which we will delve into in a subsequent paper.
Periodic Auctions in the U.S.
Periodic Auctions in the U.S. are available on Cboe’s BYX® Exchange, and unlike Europe, Periodic Auctions in the U.S. are integrated within the continuous book. Members can send Periodic Auction Only orders that will only execute in a Periodic Auction or Periodic Auction Eligible orders that can trade in an auction or in the continuous book. Both Periodic Auction Only and Periodic Auction Eligible orders are non-displayed. Continuous book Displayed and Non-Displayed orders, such as Mid-Point Peg Orders, are not eligible to initiate a Periodic Auction, but may be swept into the auction at the end of the auction process.
Once a Periodic Auction is initiated, a Periodic Auction message will be generated and disseminated via the Proprietary Depth of Book Market Data Feed at a randomized time prior to the end of the 100-millisecond fixed auction. The Periodic Auction message will include an indicative price and matched size; however, no imbalance information is included. Members may opt in to using a port setting to “lock in” their orders and prevent cancelation of marketable orders during an auction. Exchanges, unlike Alternative Trading Systems (ATS) or Actionable Indications of Interest (IOI) from high touch desks, are equal and fair access. These intraday auction mechanisms help create an equal and fair market for market participants and investors to either initiate or respond to such auctions.
The Benefits of Periodic Auctions in Europe
Cboe Europe was a pioneer in the periodic auctions arena, introducing its Periodic Auctions platform in 2015. Before the implementation of MiFID II in 2018, Periodic Auctions gained prominence as a European equities trading method. Periodic Auctions served as a response to the demand for an alternative execution mechanism that had a minimal market impact, a need that arose due to limitations imposed on other trading methods such as dark venues and broker crossing networks. Under the regulations imposed by MiFID II, Broker Crossing Networks (BCN) were closed unless the BCN converted to a Multilateral Trading Facility (MTF), and dark books were capped to 4% of individual venue share in any individual stock, and to 8% for all dark venues in aggregate. Unlike BCN’s and Reference Price Waiver (RPW) venues, Periodic Auction books are considered lit, while still mitigating the market impact and information leakage associated with Central Limit Order Books (CLOB).
Periodic Auctions help participants minimize price impact and source price/size improvement, which they do by prioritizing order size over speed and introducing randomness in trade timing. Their discontinuous nature compared to continuous order books results in more stable post-trade price paths. The current pre-trade transparency mechanism provides market participants with the necessary information to understand the potential for trading at or near the indicative equilibrium price and volume, without exposing imbalance information. This mechanism effectively informs the participants about the trading opportunities available and encourages additional participation in price formation. Importantly, this transparency framework avoids disclosing exploitable information related to any market imbalances, leading to better outcomes for institutional investors and for liquidity providers seeking to capture spread. All these advantages make Periodic Auctions a more level playing field for investors accessing the market through broker algorithms and smart routers.
The actual auction call period is fully randomized within a maximum 100ms duration. With the precise duration subject to randomization, the auction algorithm generates a single clearing price at which the greatest volume will trade. The auction duration is randomized by design for the same reason as the listing exchange opening and closing auctions, in that it prevents gaming of the auction process. Cboe’s Periodic Auctions book has highly distinctive and more favorable mark outs than RPW or lit books, which assess the stability of prices and the likelihood of adverse price movements in the moments immediately preceding and following a trade, as depicted in the chart below.
Why are periodic auctions markouts lower than the markouts in Lit or RPW books? In Lit books, trades happen at the bid or offer, making markouts an almost automatic feature of trading if the bid/offer quantity is exhausted. In RPW books, trades happen at the prevailing midpoint of the listing venue. Markouts can be a consequence of latency in sourcing the reference midpoint price, or due to the ability of clients to trade near-simultaneously at midpoint and in the Lit book. Periodic auctions, with independent price forming and randomized end times eliminates the potential for latency arbitrage which drives the superior mark-outs in periodic auctions.
How could Periodic Auctions be integrated into different phases of a broker’s Smart Order Routing (SOR)? In a simplified model, there are three phases of a broker’s SOR. First, is passive posting to capture the spread. Second is spread crossing to capture the liquidity. Third, is liquidity seeking price improvement in between looking for midpoints and other sources of liquidity that will not disturb the Lit book bid ask. The second strategy is the easiest for brokers to implement because although Periodic Auctions is a different mechanism that publishes indicative price and volume, some brokers can ignore this data and treat Periodic Auctions as another midpoint venue. If they want to undertake passive posting in the Periodic Auctions Book, it becomes more important to ingest the market data in order to understand when the order is posted or participated in a live auction and the opportunities that may exist to capture more size.
In 2022, Cboe Europe introduced additional functionalities, including an Accept-or-Cancel (AOC) order type, which allows users to either accept or cancel orders, a passive peg order type that enables liquidity provision and spread capture strategies, and a Dark on Expiry option that allows users of Periodic Auction orders to check for midpoint liquidity upon order expiry. In July 2023, Cboe Europe introduced a new order type called PAB, Dark, Lit super sweep. The new sweep order types will allow participants to access the dark, PAB and Lit order books without the need to submit multiple orders, which is also a potential latency saving Benefit. The launch also helps expand use cases of PAB to additional phases of a broker’s SOR, while delivering execution quality benefits more widely. Historically, most brokers have integrated Periodic Auctions into the liquidity seeking phase of their SORs, but not into the passive posting or spread-crossing phases. With these order types, Cboe Europe attracts both spread-crossing and passive posting flows.
Cboe operates the largest Periodic Auction venue in European equities, accounting for more than 77% of total activity, as illustrated in the chart below. As of June 2023, Periodic Auctions represent 6.9% of continuous trading. Periodic Auctions usage accelerated with the introduction of MiFID II dark book rules, but Periodic Auctions adoption has continued independently of restrictions on dark venues, even after the Financial Conduct Authority (FCA) removed caps on dark book venues in the UK.
Cboe Europe continues to maintain its significant market share in multiple countries in Europe, depicted below.
Periodic auctions exhibit high success rates once they commence. Notably, there was an increase in the percentage of successful auctions observed after February 2023, as shown below, and as of July 2023, Periodic Auctions had an 81.4% success rate.
The Benefits of Periodic Auctions in the U.S.
Cboe introduced Periodic Auctions in the U.S. to incentivize larger-sized liquidity that normally executes on ATSs and bring that type of trading on-exchange. The figure below illustrates the average trade size in Periodic Auctions compared to the average trade size on an ATS and other exchanges, excluding opening/closing auctions. The average Periodic Auctions trade size in 2023 is 125 shares, 7% larger than the average trade size on an ATS and 11% larger than the average exchange trade size. Often, Periodic Auction executions are the largest print for a symbol on a given day, including the opening and closing auctions and off-exchange trades.
A Periodic Auction is initiated when a Buy Periodic Auction order is eligible to trade with a Sell Periodic Auction order within the auction collar price range. A single order does not always initiate an auction as a change in the National Best Bid or Offer (NBBO) can start an auction. In order to identify orders that initiated an auction, we looked at the most recent order to become tradeable and an auction was initiated in that symbol. When looking at Periodic Auction Only orders that initiated an auction, the auction success rate—meaning the auction was initiated and completed— continued to increase as Periodic Auctions started to see more adoption post-launch. In July 2023, Periodic Auction Only orders that initiate an auction had an 85% success rate.
Periodic Auction executions provide a significant improvement in execution quality compared to BYX continuous book orders. The figure below highlights post-trade markouts for Periodic Auction orders that execute in a Periodic Auction and those that execute in the BYX continuous book. Executions in a Periodic Auction experience minimal slippage up to one second after the execution occurs. This provides evidence that investors are better protected from adverse selection when they execute in an auction compared to executions in the continuous book.
As we continue to see the growth in Periodic Auctions in Europe and the U.S., it is important to highlight the ways Cboe has innovated to create unique offerings for sourcing liquidity in the marketplace. Although Periodic Auctions are an alternative to ATSs in the U.S., they should also be seen as complementary to ATS venues as sourcing liquidity continues to be challenging when only using an ATS.
Periodic Auctions offer execution benefits to investors globally, whether in a more established intraday auctions market in Europe and the more recently developed Periodic Auctions market in the U. S. There are many similarities and a few subtle differences between Periodic Auctions in Europe and the U.S.., and they have proven to be a successful way to trade in both regions. Cboe’s Equities Execution Consulting Teams will continue to monitor the performance of Periodic Auctions in both regions and share meaningful insights in all our products around the globe.
Please reach out to Cboe’s North American or European Equities Coverage Team with questions and to learn about how we can help optimize your trading experience.