The manager of the Norwegian Government Pension Fund Global (GPFG) has shone a spotlight on the way closing auctions work on stock exchanges, as the end-of-day liquidity events increase their dominance in price-setting over continuous market activity.
In a new analysis revealed by Norges Bank Investment Management (NBIM), the central bank arm stressed the importance of the auctions – the final event of the trading day, which is designed to determine the closing price for each stock.
In an Asset Manager Perspective paper entitled “The role of closing auctions in well-functioning markets”, NBIM said: “Well-designed closing auctions can attract natural liquidity interest contributing to efficient price and liquidity discovery.
“The design and implementation of closing auction mechanisms should be evaluated to ensure that they contribute to well-functioning markets, and especially to efficient price discovery,” it said.
Even though continuous markets had historically been the main venue for price discovery, NBIM said, the volume share of closing auctions had seen tremendous growth over the last few years for several potential reasons.
These included the rise of investment strategies benchmarked to the closing price; the changing mix and concentration of market participants, and the resulting increasing cost of liquidity, the manager said.
Because of their crucial role, the oil fund’s manager said – and because exchange and broker offerings were evolving so rapidly – further work was needed by brokers in order to improve the efficiency of these auctions.
NBIM cited a number of benefits of continuous markets that were currently not entirely available in a discrete matching market such as closing auctions.
In the paper, it also mentioned practical aspects of stock exchange conditions that could hamper efficiency, given the growing role of closing auctions.
“We believe that exchanges should continue their efforts to ensure that market mechanisms reflect the needs of the changing sets of market participants. In the context of closing auctions, we recommend a more thorough review of the mechanisms used,” it said.
“We believe that further development work by brokers is required, both in the forecasting of auction volume and in the order submission and signalling strategies,” said NBIM.
The Oslo-headquartered manager said its Asset Manager Perspective papers articulate its views and reflections on issues topical for the financial industry, but are not intended to be definitive.