The Board of Hong Kong Exchanges and Clearing Limited (HKEx) today approved the Phase 2 proposal for the reduction of minimum trading spreads, which applies to securities trading between $0.25 and $20.
Statistical findings collected following the implementation of the Phase 1 proposal indicate that the initial reduction of minimum spreads has enabled investors to buy and sell securities at more price levels within a given price range than before. Findings also revealed that bid-ask spreads narrowed, increasing the chance of order execution at the marginal prices inside the previous spreads and thus improving market efficiency.
The HKEx Board’s decision was made after the successful 4 July 2005 implementation of the spread reduction for securities trading above $30 (Phase 1), and after reviewing trading and market data for the first six months following Phase 1 implementation.
Based on the analysis, the bid-ask spreads for stocks trading above $30 had narrowed significantly over the review period as had those for the related derivative products including derivative warrants and stock options. The effect was even more pronounced for more liquid stocks. For instance, snapshot average bid-ask spreads for HSBC, Hang Seng Bank, and Hutchison Whampoa shares were reduced by 80 per cent, 79 per cent, and 78 per cent respectively after minimum spreads were reduced (ie reduced from 0.50 to 0.10 for HSBC and Hang Seng Bank, and from 0.25 to 0.05 for Hutchison).
Since the bid-ask spread is considered by many market participants to be a component of transaction costs, the findings suggest that the objective of reducing transaction costs through the reduction in minimum spreads was met for securities trading above $30.
There did not appear to be any adverse impact on market liquidity/turnover during the review period. Also, no adverse system operations were observed in respect of the loading on trading systems since the Phase 1 implementation. More importantly, it appeared that the trade-to-order ratio had improved from 0.49 to 0.65 for stocks trading above $30 after the spread reduction because investors were more prepared to execute orders at the now narrower spreads. There was also a material reduction in the amount of limit orders lined up at the bid and ask queues, which may have been due to the increased execution of orders at market prices instead of the queuing up of orders in the form of limit orders. During the review period, daily average intra-day volatility of stocks remained relatively stable for stocks priced over $30 as well as for other stocks. Lower daily average intra-day volatility is perceived to have negative effects on day-trading activities.
It has been noted that there was some increase in order modifications for stocks trading above $30 after the spread reduction (seven more modifications per 100 orders) due to more changes in trading prices resulting from narrower spreads, but it is believed that the relatively small change is manageable.
For securities trading between $0.25 to $20, a total of 75 per cent of the orders are processed by the top 53 brokers (out of total of about 425) and all of them use advanced computer systems connected through AMS/3 Open Gateway to manage their order books and a number of them are prime online trading providers. The second half of brokers (a total of about 213), who tend to use less sophisticated AMS/3 trading terminals for order management, place no more than 85 orders on average per day for securities in this price range and together they account for about 4 per cent of the order activities for securities priced between $0.25 to $20.
In view of the positive results achieved in Phase 1 and taking into account the many comments received, as well as market opinion, the Board decided to proceed with the Phase 2 proposal, which will be the final phase of the spread reduction project.
Attachment 1 shows the spread changes that will result from the implementation of the Phase 2 proposal while Attachment 2 provides a summary of key data before and after the introduction of the Phase 1 reduction.
Phase 1 involved securities accounting for approximately 6.5 per cent of total order activity, while Phase 2 will involve securities accounting for approximately 60 per cent of total orders at all price ranges.
As at 31 December 2005, Phase 2 will extend the spread reduction from 28 securities (24 stocks plus four other securities) to about 1,429 securities (805 stocks plus 624 other securities), which account for about 85 per cent of total market turnover (28 securities covered under Phase 1, involving 25 per cent of turnover; 14 securities trading from $20 to $30 [no change in spreads], involving 2 per cent of turnover; and 1,387 securities trading from $0.25 to $20, involving 58 per cent of turnover). It should also be noted that all underlying stocks of stock options and stock futures and of single stock derivative warrants will be covered under Phase 2.
Subject to the approval of the necessary rule changes by the Securities and Futures Commission, the Phase 2 proposal is expected to be implemented in July this year. HKEx will inform market participants of implementation details as soon as they are available.
Attachment 1
Phase 2 Reduction of Minimum Spreads1