In lower Manhattan, the New York Stock Exchange’s bell rings at 4 p.m. ET each trading day, signaling a giant auction that determines the closing prices for thousands of stocks.
Seconds later, across town, Goldman Sachs Group Inc.’s trading systems pair up buyers and sellers on tens of millions of shares—using the price published by the NYSE but avoiding the Big Board entirely.
Goldman leads a pack of investment banks that are elbowing into the crucial exchange business of end-of-day trading. The share of closing-price trades executed outside of exchanges, by broker-dealers like Goldman, doubled from mid-2015 through the end of last year, from 16% to 32%, according to data from Virtu Financial Inc., a major electronic trading firm in U.S. stocks.
In the past, banks would route orders for such 4 p.m. trades to the NYSE and Nasdaq Inc. But as the exchanges raised fees in the past few years, banks like Goldman and Morgan Stanley sought to execute more of these orders in private, off-exchange transactions. Credit Suisse Group AG and UBS Group AG have also recently stepped up businesses aimed at handling end-of-day trades.
The shift raises questions about transparency and comes as more financial activity of all stripes is shifting away from public markets. Some traders and exchange executives worry that the NYSE’s and Nasdaq’s end-of-day prices— which serve as daily checkups on thousands of global companies—could become less reliable as measures of investor sentiment. And some investors fret that banks might be extracting trading profits from clients’ orders.
The change threatens the NYSE and Nasdaq, which have collected hundreds of millions of dollars in trading fees from their closing auctions in recent years.
It also shows that some banks, after lean postcrisis years, are leaning into their trading arms, eager to take on more risk in plain-vanilla businesses like U.S. stocks.
Trading around 4 p.m. has surged over the past decade, in part because of the trillions of dollars flowing into index funds that mirror broad baskets of stocks. Such funds tend to do a lot of trading at the market’s close because the indexes they track are based on end-of-day prices.
As index giants piled into the close, the flood of orders they brought with them attracted other investors, including more traditional stock pickers. Last year, trades in the closing auctions accounted for more than 8% of volume in S&P 500 stocks, nearly four times the level in 2004, according to Credit Suisse.
That has led some banks to build up a business called the “guaranteed close.”
It works like this: Investors looking to buy or sell shares of Apple Inc. can get a guarantee from an investment bank to honor their orders at the closing price set on Nasdaq, where Apple is listed.
At 4 p.m., the bank pairs Apple buyers with Apple sellers. It can send unmatched orders to the exchange or take the other side of the trade itself, storing the extra Apple shares or short interest on its books overnight.
Goldman is the largest player in this market, handling between 60 million and 80 million shares on a typical day, according to people familiar with the matter. Morgan Stanley, the top stock-trading shop on Wall Street, has a competing product, internally dubbed MOCHA, for “market on close handling aggregator.”
What began at these firms as internal tools to help centralize orders has since been pitched to clients as a way to save on exchange fees. The products are used by index-fund managers including Vanguard Group and BlackRock Inc., as well as smaller broker-dealers, people familiar with the matter said.
Yet some clients are wary. “To me, it’s a black box,” said Mehmet Kinak, global head of systematic trading and market structure at T. Rowe Price Group Inc. He said T. Rowe, which manages $1.04 trillion, avoids guaranteed-close trading because it is “completely nontransparent.”
The NYSE, owned by Intercontinental Exchange Inc., cut its closing-auction fees in January. The move was partly in response to the threat from the banks’ bustling 4 p.m. business, a person familiar with the matter said.
Executives at NYSE and Nasdaq say they fear that if more trading moves to banks, it will make closing prices less trustworthy, undermining a key pillar of the U.S. stock market.
Generally, cheaper fees benefit investors. But some traders said they are worried about what happens if a bank can’t find a matching order.
If Goldman has client orders to buy 100,000 shares of Apple and only 70,000 “sell” orders, the bank might need to scramble to fill the demand at the end of the day.
So it might turn to the exchange and buy 30,000 Apple shares before 4 p.m., which solves its problem. That buying, though, could nudge up Apple’s closing price—resulting in a worse outcome for the buyers.
In an agreement that it asked one prospective client to sign, Goldman acknowledges that efforts to execute the trade while protecting itself from adverse price moves “may impact market prices” in ways that are unfavorable to its clients, according to a copy reviewed by The Wall Street Journal.
“I know I’m getting the closing price,” said Mr. Kinak, of T. Rowe. “But I don’t know that it’s the best price I could have achieved.”
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