Orrick - Structured Finance Group

[author: Aoife Casey]

On June 11, the European Securities and Markets Authority (ESMA) published its final report (ESMA70-156-1035) following a call for evidence on frequent batch auctions, a type of periodic auction trading system for equity instruments under the MiFID II Directive (2014/65/EU) and the Markets in Financial Instruments Regulation (600/2014) (MiFIR).

Applying the provisions of MiFID II, ESMA identified that frequent batch auctions were rapidly gaining market share. Given concerns that the auctions could be used to circumvent the double volume cap, ESMA published a call for evidence in November 2018. The final report contains feedback from the call for evidence and set out ESMA’s analysis of developments in equity trading. Next steps were also highlighted.

ESMA has identified four main characteristics of frequent batch auction trading systems:

  • Limited pre-trade transparency: ESMA agrees with the views expressed by responses that market operators should be free to decide which type of the two frequent batch auction systems they intend to operate. However, ESMA considers it important that any auction system operated provides market participants with information that an auction has started to allow for genuine pre-trade transparency. ESMA intends to publish guidance to clarify this.
  • Short auction duration: ESMA does not consider it necessary to take further action on this characteristic of frequent batch auctions.
  • Price determination within the best bid and offer price: ESMA remains concerned that the three practices identified in the call for evidence may weaken the price determination process of frequent batch auctions and serve as a vehicle to circumvent the double volume cap. It therefore intends to issue guidance clarifying that frequent batch auctions should be genuinely price-forming to operate without a waiver from pre-trade transparency.
  • Self-matching features: ESMA will clarify through guidance that the use of self-matching should not, for any trading system, in any circumstances, be used to formalize pre-arranged trades.

Based on the evidence gathered, ESMA’s future work will focus on pre-trade transparency and the price determination process of frequent batch auctions. In addition, ESMA will look at the broader effects of the MiFID II transparency regime, including the general development of the market structure in its upcoming MiFID II review reports.

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