Group Co.
The IEX Auction: Pursuing Better Price Discovery
Traders Magazine Online News, September 20, 2017
In U.S. equities, the auction is a fundamental form of price discovery in which buy and sell interest of varying prices trade at a single market clearing price. The price of the auction is important not only to those who are part of the event, but to all those who use it as a benchmark. Confidence that an auction functions in a fair, simple, and transparent manner helps maximize auction participation and ensure that the auction results in a clearing price that most accurately represents the market.
This piece will dive into three principles behind the design of IEX’s auction process and highlight several key points of differentiation.
Principle #1: Familiar Functionality
Auctions are utilized by a broad spectrum of participants, so it was essential that we avoid arbitrarily deviating from established expectations. To evaluate where we could adopt attributes that were similar to existing exchange auction models?—?and therefore familiar to market participants?—?our design process began with an extensive review of the auction designs of NYSE, NYSE Arca, Nasdaq, Bats, and the London Stock Exchange (“LSE”), as well as discussions with buy-side and sell-side market participants, including asset managers, institutional investors, broker-dealers, and electronic market makers.
Based on that research, we chose auction timing which aligned with that of Nasdaq. Simply entering On-Open orders by 9:28 a.m. and On-Close orders by 3:50 p.m. will ensure participation in the IEX Opening and Closing Auctions.
Principle #2: Maximize Participation
Noam Nisan, an award-winning professor of computer science, discussed in his research on mechanism design that “generally speaking, the more buyers and sellers there are in a market, the more the situation becomes close to the perfect market scenario.”[1] During the auction design process, therefore, our primary goal was to maximize participation to provide an efficient price discovery process, minimize volatility resulting from unfulfilled interest[2] and offer greater opportunity for execution at the official auction price.[3]
To garner broad participation, IEX does not charge for market data, connectivity, or membership.[4] Additionally, we chose to limit the number of new order types that would be eligible for IEX Auctions, thus simplifying the tools at the disposal of participants and the resulting interactions in an IEX Auction. Moreover, we minimized restrictions on expressing interest in the Opening and Closing Auction, akin to the model employed by the LSE and other European exchanges, which accept new orders and allow users to modify or cancel auction-specific interest throughout the call period until the auction match.[5] It is important to note that the LSE, for example, can extend the call period for a variety of reasons; this led us to our next principle.[6]
Principle #3: Incentivize True Limits
Research in algorithmic mechanism design has shown that true expression of intent provides the optimal outcome.[7] Based on that principle, IEX’s auction design aims to balance the objective of incentivizing participants to express their true limit on auction-specific interest with the ability to conduct these auctions at 9:30 a.m. and 4:00 p.m.
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