* Closing auctions account for about 20% of European equity volumes

* CBOE, Aquis launch rival platforms

* Trend may drain liquidity during day, distort prices

By Josephine Mason

LONDON, Aug 19 (Reuters) – The final five minutes of trading have become the busiest time of day for stock market traders in Europe.

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Aside from an initial burst of activity after the open in the morning followed by a brief flurry when Wall Street opens, a growing portion of the daily equity volumes is now concentrated into the five-minute closing auctions at the end of the day.

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The growing popularity of passive and index-tracking funds and tougher regulations are driving the shift, which is draining liquidity in the $11.1 trillion market and raising concerns about big price swings and possible disruption to price discovery.

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The trend is also fracturing the industry as rivals look to take a slice of the action by launching their own post-close trading products. If sustained, it will likely stir the debate about whether there is even a need in the long term for an elongated trading day

Products like exchange-traded funds (ETFs) and hedge funds typically use end-of-day prices set during the closing auctions for their daily pricing

Equity ETFs in Europe have ballooned in recent years and are now worth about 500 billion euro ($558 billion). That’s up more than 8% in the first half of the year and a whopping 38% from January 2017, according to Morningstar data

With their rise, the five-minute window between 1530 and 1535 GMT each day is capturing a bigger portion of daily volume, which averaged about 70 billion euros in June

Closing auctions across Europe’s major bourses have on average accounted for 20% of daily average volumes in the first half of this year, and hit their highest on record of 23% in June, according to Rosenblatt Securities which tracks volumes

That’s up from just 13% three years ago. There is a similar trend in the United States, where activity is also clustering in the auctions

Activity typically spikes in the final month of each quarter, as funds scramble to participate in the auctions that set the value of their investments for the quarter

This year though, there has been a pronounced and steady rise each month as banks, brokers and asset managers find the auctions provide the deepest pool of liquidity

The rest of the day is meaningless and you can’t see flow,” said Andrea Vismara, chief executive office at Italian boutique investment bank Equita

The jump has been particularly noticeable this year as overall trading volumes have slowed amid tighter regulation and rising costs and as investors have in general shunned equities even as prices have soared

Onerous paperwork imposed by the EU Markets in Financial Instruments Directive (MiFID II), which came into force early last year, has also helped drive the shift. The reporting process for regulatory purposes is simpler if trading is executed at the closing auction

The trend has drawn the scrutiny of the French market regulator Autorite des Marches Financiers (AMF), which warned last month that lower liquidity may distort price-setting mechanisms and increase price swings

Closing auctions on Euronext’s Paris blue-chip CAC 40 stock index account for as much as 40% of volume, it found

The associated risks are a deterioration in price formation and liquidity during trading sessions, not to mention the operational vulnerabilities at the end of the day given the volumes concentrated in the closing auction,” the watchdog said in its report

LIQUIDITY BEGETS LIQUIDITY While it’s not clear if it has yet disrupted price formation, interviews with a dozen traders and senior executives at international banks, brokerages, wealth managers and exchanges show that the trend is upending how they do business

For a start, liquidity begets liquidity – as more traffic goes through the closing auction, it has a self-amplifying effect

“In many cases, volumes in the closing auctions are so significant they cannot be ignored,” said Derek McCole, head of equity dealing for EMEA at Aberdeen Standard Investments

He has adjusted to the new norm. He tends to place a percentage of an order at the settlement price in the closing auction and then opportunistically trade the rest of the order if a certain price is hit

But some executives say it is getting more difficult to do big block trades during the day, forcing many to save large transactions until the end of the day. That leads to even lower liquidity during the remaining 8-1/2 hours

The market opens, nothing happens and then the U.S. come in. It’s busy for the first hour and then it quietens down,” said a senior executive at a global bank

“People are struggling to get orders done. If people are looking for blocks, they wait until the closing auction.”

RARE SOURCE OF REVENUE For exchange operators like Deutsche Boerse and the London Stock Exchange, the rise of closing auctions provides a rare and much-needed source of revenue

The exchanges often charge higher fees to transact in the closing auction compared with intraday levels. Each bourse has a different fee structure so it’s hard to pinpoint an exact premium

But signs have emerged that the financial industry is divided over the trend, with CBOE Europe and Aquis Exchange launching rival platforms to break the exchanges’ monopoly

CBOE says it will not charge customers until the end of the year to use its 3C product, while Aquis charges a fixed 10,000 pound subscription

Aquis Chief Executive Alasdair Haynes said he wants his company’s Market at Close product to provide competition to the exchanges. He estimates the fees for closing auctions are costing the industry an extra 75-100 million pounds each year

The product got UK regulatory approval a few years ago, but it has only seen volume pick up in recent weeks, a spokeswoman said

That rise in interest has come as banks aim to slash costs due to razor-thin margins, which have been eroded by the burden of extra regulation and lower volumes

There is no doubt there is a correlation with banks trying to save money and the interest in our product where there’s a serious cost reduction for the banks,” Haynes said

But the Aquis and CBOE foray has, in turn, stirred worries about drawing liquidity away from the main exchanges

There’s a perception that the exchanges exploit their monopoly position for the closing auctions, so the lower fees offered by alternative products may be attractive for brokers,” said Rosenblatt Securities’ market structure analyst for Europe, Anish Puarr

But “there may be a danger in fragmenting” liquidity in the auctions, which provide a vitally important official closing price, he said

Investors like Equita and Aberdeen are also worried that alternatives could attract volumes away from closing auctions, distorting price creation

“As these different ways of trading the close appear, that could potentially weaken the existing closing structure if liquidity gravitates away from the primary market onto these other mechanisms,” said McCole. ($1 = 0.8950 euros)

Reporting by Josephine Mason; additional reporting by Simon Jessop in LONDON and Inti Landauro in PARIS; Editing by Hugh Lawson