Twenty years ago, trading shares in a company was a simple business. You could call a broker and they would buy or sell shares in a company on your behalf, sending the order to the listing market, either the New York Stock Exchange or Nasdaq, to get the best price.
Fast forward and we have a very different environment. Regulatory change, namely the introduction of Reg NMS, created strict rules that require investors to interact with multiple market centers. This created competition that benefited retail investors and reduced explicit fees, but also resulted in fragmentation of liquidity. Because order flow now rests across 12 licensed stock exchanges and dozens of dark pools, sourcing liquidity is more challenging than ever for the institutional trader.
Fortunately, the NYSE Closing Auction remains a centralized, large-scale liquidity event that permits institutional investors to establish sizeable positions without undue complexity. The Closing Auction brings all buyers and sellers together into one common trade that establishes a clearing price for all interest.
The NYSE Closing Auction is the last event of the trading day, and it’s designed to determine the closing price for each stock. There are three order types that play a specific role in this process. Market-on-Close (MOC) orders represent interest that must trade in the closing auction, irrespective of price. Investors using an MOC order will have the assurance that their order will be executed. Limit-on-Close (LOC) orders seek to purchase or sell a specific number of shares but only if the closing price is at or better than their limit price. If the closing auction price is outside the investor’s limit, the LOC order does not participate. Finally, investors may enter their closing interest via a NYSE Floor Broker. The NYSE Floor Broker provides the greatest level of flexibility and discretion to investors, with the capability to enter or cancel interest up to the Closing Bell.
With today’s highly fragmented markets, the auctions are the only time in the day when investors receive the benefit of centralized liquidity, which is critical to price discovery and the stability and transparency of our capital markets. It is a process that is an intentional effort to facilitate trading in a highly complex, fragmented market place. And it provides a consistent and reliable mechanism that underpins public companies’ equity closing price. In short, the closing auction is one of the most crucial aspects of modern market structure.
Auctions are most successful when all orders are aggregated at one time. This transparency allows investors of all types to participate with the assurance that they’ll get a fair and accessible price. Because investors can confidently enter and exit sizable positions, they attribute a lower risk premium to their investment decision. This translates into a lower cost of capital for NYSE-listed companies.
The importance of the Closing Auction came into even sharper focus with the recent “Quad Witch” (a day when stock index futures, stock index options, stock options and single stock futures expire) on June 16, and the Russell Rebalance (a day when Russell rebalances its indices) on June 23. These events attracted a higher level of institutional interest and potential for greater volatility. It is essential for market stability to have this activity take place in a single process that aggregates all buying and selling interest.
Recently, Bats sought permission to direct MOC orders away from the primary exchange during the closing auction. In our view, this will distort the Closing process, insert an added layer of complexity in an already too complex system, and risk harm to investors and listed companies just to marginally reduce fees for financial intermediaries.
The auction is one of the few components of U.S market structure whose value most people actually agree upon. Until now, there’s been no cause for debate because it’s a process that’s trusted because it works.
We believe it’s important that the Closing Auction continue to take place on the primary listing exchanges because it’s indisputably in the best interest of public companies and investors.
The closing price is crucial as it represents the universal market data reference price for all equity-linked products including mutual funds, Exchange Trade Products (ETPs) and derivatives.
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