Hong Kong Exchanges and Clearing Limited (HKEx) published a consultation paper today (Friday) on the proposed introduction of a Volatility Control Mechanism (VCM) in its securities and derivatives markets and a Closing Auction Session (CAS) in its securities market.
The proposed enhancements of Hong Kong markets' microstructure are aimed at improving the global competitiveness of Hong Kong's markets. HKEx believes:
- The VCM is needed to preserve market integrity in its securities and derivatives markets, in line with regulatory guidance from IOSCO, the International Organisation of Securities Commissions, and global trading practice; and
- The CAS is needed to enable trading at securities' closing prices, which has been requested by many brokers and investors for some years.
HKEx consulted the Securities and Futures Commission, conducted extensive research of international practice and held preliminary discussions with market participants during the proposal development. Through this process, HKEx strived to ensure the proposals address both market needs and the concerns that market participants may have.
"As an international exchange, we have to stay alert for changes that may require new mechanisms to protect market integrity; at the same time, we have to be able to meet the diverse needs of brokers and investors in our market." said Roger Lee, HKEx's Head of Market Operations. "Our proposed market microstructure enhancements are designed to offer greater safeguards to our market and improve market efficiency."
Following the Flash Crash incident in the US markets on 6 May 2010, the G20 and IOSCO reviewed and considered safeguards for systemic risks arising from advances in trading technology, such as algorithmic trading, and the inter-connectedness of securities and derivatives markets, particularly with respect to benchmark index products.
The proposed VCM is based on a simple dynamic price limit model (see figure 1 below). It would cover:
- The 81 constituent stocks of the Hang Seng Index (HSI) and the Hang Seng China Enterprise Index (HSCEI)1; and
- The spot month and next calendar month index futures contracts for the HSI and HSCEI, or H-shares index, and their respective mini futures contracts.
Under the proposed VCM:
- The trading of the instruments covered is monitored against a dynamic price range (±10 per cent for stocks and ±5 per cent for futures contracts from the last trade 5-minutes ago) during the morning and afternoon continuous trading sessions, excluding the last 15 minutes in the afternoon.
- A 5-minute cooling-off period of trading within a fixed price range is triggered if the next potential trade of a covered instrument would exceed the dynamic price range. Linked instruments such as derivative warrants are not affected. The purpose of the cooling-off period is to allow market participants to reassess their strategies and reset algorithm parameters. Normal trading resumes after the cooling-off period.
- Each covered instrument is limited to a maximum of four cooling-off periods – two in the morning and two in the afternoon – per trading day.
All developed markets except Hong Kong and most developing markets2 have a CAS to enable trading at the closing price, which is part of the mandates of some institutional investors, index trackers and pension funds.
HKEx has received numerous requests for a CAS since the one it introduced in May 2008 was suspended the following March due to HKEx's concerns about any appearance of abuse during the CAS and the need to maintain public confidence in the orderliness, fairness and transparency of the market in light of some unusual price movement. Accordingly, HKEx has proposed an enhanced CAS model (see figure 2 below). It includes:
- A two-stage price limit (first stage: 5 per cent price limit with reference to the end of the afternoon trading session; second stage: within highest bid price and lowest ask price);
- Random closing;
- Enhanced market data transparency; and
- Allowing at-auction limit orders all the way to the end of the CAS.
These measures are based on international experience in addressing price instability in closing auctions, and HKEx believes they are appropriate for its markets.
In addition, a two-phased rollout is proposed. Phase 1 would cover the most liquid index constituents (effectively the stocks which are included in Stock Connect for Southbound trading) and related Exchange Traded Funds, or ETFs. When the market is familiar with the new mechanism, the CAS would be expanded to all remaining equity securities and funds.
Further details of HKEx's proposals are highlighted in the questions and answer and the presentation.
The consultation paper and questionnaire can be downloaded from the HKEx website. Interested parties are encouraged to respond to the consultation paper by submitting the questionnaire. The deadline for responses is 10 April 2015.
1. The number of securities is as of 31 December 2014.
2. Based on MSCI country classification.
Figure 1: Proposed Volatility Control Mechanism
During CTS except the Last 15 Minutes
CTS – Continues Trading Session in securities market: 9:30 am to 12 noon (morning session) and 1pm to 4 pm (afternoon session).
POS – Pre-Opening Session in securities market: 9 am to 9:30 am.
Figure 2: Proposed Closing Auction Session
IEP: Indicative Equilibrium Price. The IEP is the indicative auction price for matching at any time during the auction process as if the auction is concluded then. It is generally the price within the highest bid and the lowest ask and at which the aggregate volume of matchable orders is maximised.