Introduction of new call auction in SEATS in 2002

The ASX operates a fully automated order-driven trading system, known as the Stock Exchange Automated Trading System (SEATS). Limit and market orders are executed in a continuous auction between 10:00 and 16:00 on the basis of price then time priority.

A call auction is used to open and close the market each day. The opening call auction occurs in five batches of stocks between 10:00 and 10:09. Each batch opens randomly up to ± 15 seconds from its designated opening time. The closing call auction occurs randomly between 16:05 and16:06, except on quarter-end days and other month-end days where it occurs randomly between 16:10 and 16:11. Each call auction is preceded by a pre-open period during which time orders may be entered, amended and cancelled without restriction. The morning pre-open operates between 7:00 and the random open, while the afternoon pre-open period (pre-close) operates between 16:00 and the random close. Undisclosed orders are available where all or part of the order volume may be hidden from the market. The hidden part of the order must always have a value greater than AUD200, 000 or the order volume will be disclosed to the market. The hidden part of the order is always executed before the disclosed portion, and price then time priority applies. No official market-makers/liquidity providers operate on the ASX at any time.

The ASX introduced a number of preliminary changes to the design of the closing call auction prior to 18 March 2002, to reduce volatility on quarter-end days. These included prohibiting the entry, and restricting the amendment of, undisclosed orders in the pre-close from 25 June 2001, extending the preclose period to fifteen minutes on the last day of the March and June quarters 2001, abandoning the closing call auction on 28 September 2001, and indefinitely extending the pre-close from five to ten minutes on all month-end days from 30 November 2001. The most significant action aimed at reducing volatility on quarter-end days was a decision made by the SFE, in consultation with the ASX, on 28 September 2001, to decouple SPI 200™ Futures Contract settlement prices from closing prices (a temporary SPI 200™ Futures Contract settlement price arrangement was introduced for that day). Since 31 December 2001 the SPI 200™ Futures Contract settlement price is based on a Special Opening Quotation calculated using opening call auction prices. This change should reduce index arbitrage activity at the close, and as a result, reduce price volatility.

The final changes to ASX call auction design were introduced on 18 March 2002. They address two limitations identified in ASX call auction design, the matching algorithm and the level of pre-trade transparency. Although trading on quarter-end days drove these changes, they apply at all times a call auction is held.

The previous algorithm determined a single weighted average price based on the price and volume of the last two orders matched in the order book. This algorithm had a number of limitations. Many orders failed to execute even though they were entered at prices better than the official call auction price, and the auction price could be manipulated. Furthermore, traders had an incentive to enter orders at unrepresentative prices, which ensures execution as orders are matched in price/time priority. In addition, the weighted average price calculation would ensure a trade price better than the unrepresentative price.

While transparency of the order book at the opening call auction remained high, it was limited by the presence of undisclosed orders. Transparency of the order book at the close was also constrained. Undisclosed order restrictions introduced on 25 June 2001 increased pre-close transparency, though as undisclosed orders can still be carried forward into the pre-close from the continuous trading session, traders are unable to determine the opening and closing price with certainty.

The new call auction eliminates many of the limitations of the previous call auction design. It reduces the impact of unrepresentative orders and the problem of unfilled interest at prices better than the auction price. This is achieved through a relatively simple price-setting process that follows four principles. Principle 1 maximizes trading volume. If there is more than one price where trading volume is maximized, the algorithm then considers Principle 2. Principle 2 considers the range of prices where trading volume is maximized and selects the price within this range where order imbalances are minimized. If there is more than one price where order imbalances are minimized, the algorithm then considers Principle 3. If all of the prices that exhibit the minimum order imbalance attract buy (sell) surplus volume, Principle 3 sets the highest (lowest) of these prices as the opening price. If both buy and sell surplus volumes are present at these prices, then Principle 4 is considered. Principle 4 sets an auction price based on a reference price, the previous closing price (or the last traded price of the day for the closing call auction). Detailed examples of the price setting process, based on the new and old algorithm, are presented here.

The implementation of the new algorithm also allowed for a change in the level of pre-trade transparency. After 18 March 2002 the ASX began to disseminate an Indicative Auction Price (IAP) and Surplus Volume (SV) indication in real time throughout the pre-open and pre-close period. Hence, traders know the indicative opening price at any time with certainty, are no longer restricted by the presence of undisclosed orders, and are able to identify any order imbalance present at that price.