Best Execution speaks to Simon McQuoid-Mason to learn more about how the new Auction Volume Discovery (AVD) order-type, which went live this week, can help traders to execute bigger orders and improve liquidity without impacting price.
European cash equities markets have in recent years seen a significant uptick in the value traded in primary auctions. Exchanges are seeing increased appetite from the industry to execute in auctions, primarily (of course) at the close, but there is – according to SIX Swiss Exchange – “understandable” caution in having excessive price impact, which drives many to self-limit their orders. These participation caps/rates can leave contra-liquidity on the sidelines of the auction – and that is what the new hidden order type is designed to address.
The new functionality is effectively a dark order type, which sits in the closing auction and allows market participants to put in residual liquidity that would usually be kept out of an auction due to the application of participation cap constraints. “The AVD order-type basically provides a way of facilitating that sidelined liquidity to be sent into the closing auction,” explains Simon McQuoid-Mason, head of equity products for the UK and Ireland at SIX Swiss Exchange, speaking to Best Execution.
Because no one can see it, the order type therefore doesn’t contribute to price and volume updates, so there is no price impact. But at the auction uncross, if there is overhang liquidity or other AVD liquidity in the auction, it will match against that at the closing price – essentially “stitching together” capped-out liquidity.
If an order does not find contra liquidity to match against, then there is no trade – but crucially, the existence of the order is not disclosed to the wider market.
According to SIX, the demand is there – and it’s substantial, with client concensus suggesting that participation capping on orders is both frequent, and the capped-out liquidity levels meaningful.
“When we spoke to the market, a re-occurring theme was that a lot of buy-side orders that are intended to be traded in the close are actually constrained by participation caps based on the theoretical uncross volume,” says McQuoid-Mason. “But if participation caps are applied across the market at large, then you potentially reach a point where actually there’s a bunch of latent liquidity that market participants do want to trade in the auction, but don’t because they don’t want to unnecessarily shift the uncross price.
“This liquidity is being held back from the auction and is also fragmented across different brokers, which limits the ability to find the contra side. There is often good reason to want to trade that liquidity in the close, on the same day, rather than risk a significant close to open price deviation – which can be up to 200bps overnight depending on macro-factors and news that comes to market post-close.
“If you don’t get all your displayed orders executed, then the market knows overnight that there is a significant overhang, and that can affect the directionality of prices the next morning.
This new functionality is therefore a way that market participants can opportunistically try to find additional contra side liquidity from within the existing, fragmented pool of latent liquidity that is currently being prevented from participating in the auction due to caps.
First announced in April 2023, the order type went live this week (15 May) – and has already met with positive reactions. “We’ve had really strong feedback from the buy-side,” says McQuoid-Mason. “Pretty much everyone we spoke to bought into the concept and saw a use-case somewhere within their existing flows, given their experience of seeing orders constrained by participation caps. It can be somewhat frustrating to sit there, see an attractive theoretical closing price and think I’d like to print more at that price if I could.”
Perhaps more notably, the order type has met with a strong response from the wider market as well.
“The agency brokers have really jumped on this,” reveals McQuoid-Mason. “In addition, we thought AVD might get a lukewarm reception from bulge bracket brokers, given that they offer alternative close products, but actually their reaction has been positive. I think they understand that they’re never going to service the whole of the market, so there will be a natural limit on the ability to internalise.”
So far, the service has seen mainly test orders this week since going live, but the exchange is expecting a strong take-up as a means of sourcing additional liquidity and as an alternative option to manage market impact – especially as more and more asset managers seek access to auction liquidity without moving the price against themselves.
“We see AVD as pragmatic innovation that supports market evolution,” concludes McQuoid-Mason.
The Swiss stock exchange introduced its own non-displayed pool SwissAtMid in 2016, gradually substituting its previous tie-up with Liquidnet (the SIX Swiss Exchange Liquidnet Service, or SLS for short). In 2022, SwissAtMid was the largest pool of liquidity among non-displayed and periodic auction venues in Swiss equities with a market share of 28.4%. In Q1 2023, CHF13.6 billion was traded in the pool, and more than CHF350 billion has been traded since launch. Orders with a size larger than LIS thresholds accounted for 23% of turnover in March 2023, and last month, a new record was set by the Block Solution for SwissAtMid last month, with over CHF560 million executed in conditional orders, meaning turnover almost doubled from the previous high.
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