Hong Kong Exchanges and Clearing (HKEX) has initiated a 12 week period of consultation on the long-awaited question of the reinstatement of the market’s closing auction, in addition to a new volatility control mechanism. In one year’s time it is hoped that both new procedures will be operational.
“For some years, many institutional investors have been saying to us that the way that their funds trade necessitate tracking a closing price,” said Roger Lee, the head of market operations at HKEX announcing the new consulation. He explained that 10% of normal volumes and up to 30% of turnover during index rebalancing days hinged on closing prices. “The inefficiencies that resulted from not having an auction have led to disputes and arguments between some market participants,” he added.
This will not be Hong Kong’s first iteration of a closing auction. One was introduced in May 2008, but suspended after 10 months due to large price fluctuations. Lee said that this time round, the exchange would absorb the lessons of 2008.
Hong Kong is one of the few jurisdictions not to have a closing auction, a dubious honour it shares with Chile, Egypt, India and Shanghai.
HKEX has devised a proposal on which it now seeks comments through the consultative process. Starting at 4.01pm the market can place (and delete) orders within a 5% range of the final 4 pm price.
Then at 4.08 pm, orders can be placed within the level of the lowest and highest bids received. They will be fixed and cannot be deleted. Next, at 4.10 pm from 4.12 pm, there will be a final closing on a random basis, designed to prevent gaming of the close taking place.
Their suggestion is that phase one of the closing auction would apply to the 280 stocks that currently constitute the Shanghai-Hong Kong Stock Connect, plus approximately 40 exchange-traded funds that track Hong Kong.
Lee said that views solicited from small and large brokers would be treated equally. In the past there has been a sentiment expressed that smaller brokers might be less happy to see the return of a closing auction as it might prejudice their revenue.
Volatility control mechanism
The HKEX proposals for volatility control are based on Singapore’s model.
“They are not designed to stop stocks going up or down, rather to prevent systemic risk,” said Lee. The G20 group and IOSCO have both proposed the introduction of volatility controls to handle risk. Of the major markets, Hong Kong is alone in not currently having done so.”
The proposed mechanism, which will include HSI and HSCEI stocks, is based on a trigger level of a stock movement of 10% higher or lower than the previously quoted price. Such a move would trigger a five minute cooling off period.
The mechanism would not apply to the opening price, nor during the last 15 minutes of the day. Trading would still continue within the cooling-off period, but within a restricted range. After the cooling off period, trading would return to normal.