The IEX Auction: Pursuing Better Price Discovery
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.” 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 and offer greater opportunity for execution at the official auction price.
To garner broad participation, IEX does not charge for market data, connectivity, or membership. 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. 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.
Principle #3: Incentivize True Limits
Research in algorithmic mechanism design has shown that true expression of intent provides the optimal outcome. 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.
To balance these objectives, we chose to deviate from the flexibility of the European model by removing the ability for participants to adjust auction-specific interest (i.e., cancel or modify) after a designated “lock-in time” or add new auction-specific interest (i.e., new orders) after a designated “lock-out time.” Additionally, IEX provides more frequent disseminations of auction data, including indicative prices calculated using all eligible interest, which allows participants to enter new auction-specific interest or adjust continuous trading behavior as they iterate towards the clearing price.
Below are some noteworthy features in IEX Auctions that build upon the existing models of our competitors to increase participation and enhance price discovery.
Eliminate Special Access — More than one-third of NYSE’s closing auction volume is from d-Quotes and other interest represented via floor brokers. The popularity of d-Quotes, which are only available via a floor broker, is driven by the flexibility to enter or modify auction-specific interest until 3:59:50 p.m. — long after NYSE’s 3:45 p.m. cut-off for LOC and MOC orders — and to even cancel such interest until 4:00 p.m. 
IEX offers the ability for all participants — not only a privileged few — to enter LOO or LOC orders until the lock-out time of the Opening or Closing Auction, 9:29:50 a.m. and 3:59:50 p.m., respectively.
Reduce Gaming — As demonstrated by our late lock-out times, we believe in affording participants the flexibility to submit auction-specific interest later in the auction process. However, flexibility should not come at the cost of enabling obvious gaming opportunities.
For example, research has shown that cancellations and modifications of d-Quotes may lead to volatile price formation once such orders are included in the NYSE indicative clearing price dissemination beginning at 3:55 p.m.
Unlike NYSE d-Quotes, IEX’s LOO and LOC orders cannot be canceled or modified after the lock-in times at 9:28 a.m. and 3:50 p.m., respectively. As a result, the incentive for non-bona fide auction interest to enter the auction after the lock-in time is significantly reduced, because such interest is committed to the auction on entry.
Disseminate More Frequent and Complete Data — NYSE only publishes auction data every 5–15 seconds and, as discussed above, begins to include d-Quotes later in the auction process.
In contrast, IEX provides greater transparency into indicative prices, imbalance, and paired shares by disseminating our free auction data once a second and including all participating orders in each dissemination.
Prioritize Price over Time — We believe auctions should be a price discovery mechanism, not a race. That’s why, unlike Nasdaq or NYSE, IEX does not offer an order type that only interacts with auction imbalance.
Whether or not a Nasdaq imbalance only order or a NYSE closing offset order participates in an auction is a function of its time priority rather than its relative price aggression. Therefore, if such order’s limit price is more aggressive than the auction price, the imbalance only or closing offset order is repriced to the auction price and participates based on its original time of entry. Prioritizing time over price creates a winner-take-all race to offset imbalances, encouraging participants to compete on the speed of their respective systems rather than price.
Minimize Special Order Types — NYSE’s d-Quotes and Nasdaq’s imbalance only orders are considered extremely valuable because they offer flexibility and the opportunity to gain an advantage without genuinely competing on price.
In contrast, IEX accepts LOO and LOC orders from all participants until the lock-out time. This facilitates flexibility similar to that offered by d-Quotes without adding a specialized order type that is only accessible by a subset of participants, or a specialized order type that only serves the fastest participants.
Protect Resting Orders — IEX’s commitment to protecting natural investors from information leakage — well known across the industry — extends to the auction.
To protect the anonymity of resting non-displayed interest on the continuous book during the auction process, IEX prices non-displayed orders resting within the spread at the near-touch when calculating indicative prices and the price of the Opening and Closing Auction (though such orders remain ranked and eligible for execution in these auctions at their resting price).
IEX Auctions were strategically designed after extensive research and informal discussion with various market participants to provide unique value to fundamental investors and the issuers that make up the subject of their investments.
In August, the SEC approved IEX’s auction design and operation. This approval was one of the key remaining SEC approvals required before our planned launch of IEX Listings in the fall. As with all products and functionality offered by IEX, research, quantitative analysis, and input from participants and the issuer community will inform future iterations of IEX Auctions, as we strive to deliver quality trading experiences for market participants and issuers.
 See Algorithmic Game Theory, Noam Nisan, Tim Roughgarden, Eva Tardos, Vijay V. Vazirani, 2007 at 209 (http://www.cs.cmu.edu/~sandholm/cs15-892F13/algorithmic-game-theory.pdf). The “perfect market scenario” is generally referred to in the academic community as a system of perfect competition that discovers the fundamental value of a product, where many participants compete for a homogenous product with freedom of entry to and exit from the market, while possessing perfect information regarding the product, and its supply and demand.
 See BlackRock Viewpoint on US Equity Market Structure: Lessons from August 25 (https://www.blackrock.com/corporate/en-au/literature/whitepaper/viewpoint-us-equity-market-structure-october-2015.pdf)
 See Trading the Auctions, Richard Johnson, 2017 (https://www.greenwich.com/equities/trading-auctions)
 See Investors Exchange Fee Schedule (https://iextrading.com/trading/fees/)
 See LSE Guide to New Trading System, Section 7.2 at 67 (http://www.londonstockexchange.com/products-and-services/trading-services/guide-tonew-trading-system.pdf). See also NASDAQ OMX Nordic Market Model 2.2, Section 4.2.3 at 16(105) (http://www.nasdaqomx.com/digitalAssets/73/73614_nasdaq_omx_nordic_market_mode l_2.2_1_april_2011.pdf). The LSE concludes the regular market session and begins a call period where orders are collected for an auction; no continuous trading occurs during the call period.
 See London Stock Exchange Guide to Release 3.1m, Section 1.3 at 8 and Section 2.3 at 18 (https://www.londonstockexchange.com/products-and-services/technical-library/technical-guidance-notes/technicalguidancenotesarchive/release.pdf)
 See Algorithmic Mechanism Design, Noam Nisan and Amir Ronen, 1999 (http://www.cs.yale.edu/homes/jf/nisan-ronen.pdf)
 Walras. Elements of Pure Economics, or the Theory of Social Wealth. Richard Irwin, 1954. (Original version published in French in 1874). In fact, such price adjustment mechanism can be viewed as a discrete version of the Walrasian tâtonnement.
 See “The Floor Broker’s Modern Trading Tool” (https://www.nyse.com/article/trading/d-quote?utm_source=navigation&utm_medium=nav&utm_campaign=tradenav). NYSE categorizes closing auction volume from “floor brokers” in aggregate in the “NYSE Closing Auction Order Flow Composition” chart, rather than d-Quote volume specifically. In contrast, floor broker interest is not independently classified in aggregate in NYSE’s monthly Order Type Usage table (https://www.nyse.com/publicdocs/nyse/markets/nyse/NYSE-Order-Type-Usage.pdf); we recommend a breakdown of floor broker participation by order type (e.g., d-Quotes, pegged e-Quotes) in NYSE’s Order Type Usage table.
 See Id.
 See “The Cost of the D-Quote” (http://www.itg.com/marketing/ITG_Blotter_CostofDQuote_20131022.pdf)
 See “NYSE Open and Closing Auctions” (https://www.nyse.com/publicdocs/nyse/markets/nyse/NYSE_Opening_and_Closing_Auctions_Fact_Sheet.pdf)
 See Id.; See also “The Nasdaq Opening and Closing Crosses Frequently Asked Questions” Question 11 (http://www.nasdaqtrader.com/content/ProductsServices/Trading/Crosses/openclose_faqs.pdf)
IEX is the Investors Exchange: a fair, simple, and transparent stock exchange dedicated to investor and issuer protection. Built on the belief that every investor is entitled to the same right to trade on equal terms on every single trade, IEX is on a mission to level the playing field by eliminating unfair advantages from the markets.
On September 2, 2016, IEX launched as America’s newest stock exchange, and regularly matches over 130 million shares daily with a notional value of over $6 billion. IEX plans to begin listing publicly-traded companies in 2017.
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