As Passive Investment Drives Closing Auction Volumes, Chi-X Takes Aim

Passive investing has been steadily growing over the past decade, as lower fees and well-diversified portfolios continue to attract investors. According to Moody’s Investor Services in a report published in March, passive investments in the US are on track to overtake active fund management by 2021. The Australian Securities Exchange (ASX) reported that market volume for exchange-traded funds (ETFs) grew 30% year-on-year in June, to A$50.9 billion ($34.58 billion). 

The rise of passive investments has led to a concentration of trading during the closing auction at exchanges, as the closing price serves as a reference for all passive products.

“Right across the globe, liquidity is being pushed into the closing auction at almost every major marketplace,” says Vic Jokovic, CEO at alternative exchange venue Chi-X Australia. “That reflects the passing from active management to passive management, where we’ve seen ETFs grow significantly both globally and locally. So there’s a lot more volume that is being executed with just the closing price in mind. Active funds by nature try to get outperformance throughout the day instead.” 

The general trend of trading volumes moving to the closing auction would depend on the different strategies an investment manager could take, as well as the market. Jackie Choy, director of ETF research in Asia for Morningstar, says there are different strategies that funds could take. This could mean going into the end of the trading day or estimating the actual closing price. 

“It depends on the actual mechanisms of the closing auction,” he says. “Different markets have different mechanisms on their closing auctions. When we talk to the ETF providers or investment managers, they often mention that it’s really down to the market environment at the time of index reconstitution. They and the traders will think about the best way to execute a trade for the benefit of their investors.”

MatchPoint Rollout
 
Chi-X Australia spoke with close to 70 fund managers and learned that they are keen to execute large orders at the close. They want to do this by referencing ASX’s market close auction price, anonymously, Jokovic says. Submitting large orders to the closing auction, though, could mean the trades are noticeable to other market participants.

To meet this demand, last week Chi-X Australia launched MatchPoint, a market-on-close (MOC) platform. Through MatchPoint, market participants can place block ADV orders anonymously between 10 am and 4:20 pm Sydney time. Orders going through MatchPoint can be submitted through an algo and is completely dark. 
 
“[Fund managers] wanted a marketplace or a place where they could put an order in, in that size, anonymously with anti-gaming technology built-in,” Jokovic says. 
 
Any orders that are not executed will be canceled at 4:20 pm so they can be executed the following day without any information being visible to the market. Participants can also apply broker preference, and/or minimum executable quantity (MEQ) to avoid exposure to strategies seeking anonymous volumes. 
 
“This minimum execution quantity logic allows them to be protected when they put an order in and potentially trade post-auction,” he says. 
 
Orders entered into MatchPoint sit there anonymously and wait to be executed. “If it gets executed, it prints to tape immediately, but if it doesn’t get executed, then nobody’s the wiser and you can trade the next day unimpeded,” Murrough O’Brien, head of institutional sales at Chi-X Australia adds. 
 
In the last few months, Chi-X Australia has endeavored to have all brokers start coding to its MOC order type. O’Brien explains that from the brokers’ standpoint, although there are different execution channels, Chi-X Australia prefers clients to put their orders in using an algo. Reasons for this include the fact that an algo is automatic, predictable, and is better at providing anonymity, he says. 
 
“Most brokers have what’s known as a MOC algo, and at the moment those MOC algos are going to the ASX auction. MatchPoint provides the opportunity to our participants and their clients to have a second chance of executing at the closing, but with the knowledge of what the closing price will be. Using an algo to access MatchPoint means that fund managers and superannuation funds can access an anonymous liquidity pool via an anonymous execution channel,” O’Brien says. 
 
The other execution channel is via a sales desk. In Australia, there are designated trade representatives, which are trade operators that clients can rely on to route orders through to MatchPoint. 
 
O’Brien says both methods use a MOC order type, which is a straightforward FIX order type. Clients can apply their own MEQ value, too, in order to reduce information leakage on the order. 
 
Orders going into MatchPoint are executed by the block, instead of being broken up into separate pieces. Usually, orders are broken up into several pieces during the day to reduce market impact, and so that other market participants can’t tell there is a big order there. O’Brien says Chi-X’s technology can help.
 
“When you put [a block] into MatchPoint, it’s anonymous, and because you have this anti-gaming, MEQ technology, you can put a very large order in there and nobody can see it,” O’Brien says. “For example, if you have 100,000 shares of CBA, and you apply a MEQ of 50,000 shares, and another participant comes in and starts trying to execute against you for one or two shares, you’re not going to execute. However, if an order for 50,001 shares arrives, it will execute as it meets the MEQ requirement. It reduces information leakage in the case where another market participant is trying to get a sense as to whether there’s a big order in the market or not.”