Efforts to resurrect the Hong Kong Stock Exchange's closing auction session (CAS), the lack of which has resulted in added costs for fund managers, are long overdue and should be brought to fruition as the exchange moves into the second year of its Strategic Plan 2010-2012, market participants say.
When it recently updated its three-year plan, the Hong Kong Exchanges and Clearing Limited (HKEx), the holding company of the Hong Kong Stock Exchange, said it would “explore possible options to enable execution at market close in view of market needs and based on its experience”. HKEx added that any future proposals “will be put forward for public consultation before implementation”, but there is no timetable at the moment. Nevertheless, market reaction has been positive.
“The fact the HKEx is thinking about putting it back in is, for a start, a very good idea. They should really follow other developed markets in using an auction mechanism where you have a fair chance of getting the close price,” says Sander Elzinga, co-head, execution services, Asia at Société Générale. “I don't think the exchange as a whole, as a result of the closing auction being re-implemented, will attract more volumes. But it will show to the world that they are moving in that direction.”
Alexander Colin-Jones, partner and CEO of broker Louis Capital Markets in Hong Kong, adds, “It is long overdue. If you look at the majority of developed markets in the world, they have a closing auction.”
Since March 2009, the HKEx has reverted to the pre-CAS method for calculating closing stock prices; the system takes up to five price snapshots at 15-second intervals from 15.59 until the close of trading at 16.00. The five snapshots are arranged in ascending order and the median is taken as the closing price.
“An investor wants to be able to place an order such that he gets the close price. The way that it works now in Hong Kong means that you have to trade in a very particular way in the last minute. And even if you do that, you are not guaranteed whatsoever to get the close price,” Elzinga explains. “During the last minute, the exchange takes five snapshots and the median of those snapshots is the close. So unless the way you traded was such that it was exactly at that price which happens to be the median, you're not going to have the close price. The investor is thus subject to volatility in the last minute.”
The HKEX issued its first consultation paper on the CAS in March 2007 and introduced the closing auction in May 2008. Following the suspension of the CAS, the HKEx issued another consultation paper on 28 November 2009 to solicit market comments on the introduction of a price control mechanism during the CAS in its securities market. It also solicited the market’s views on whether HKEx should suspend the CAS and consider re-introducing it when there is a market consensus on enhancement measures. The consultation period ended on 31 December 2009 but the HKEx has not come up with a firm proposal on the way forward.
However, the consultation paper of 28 November 2008 did not include the option of a random closing time. A random closing time during an auction makes it much more expensive for someone to manipulate the closing price, particularly if the randomness period is long enough,” says David Webb, editor of www.webb-site.com and former independent non-executive director of the HKEx.
The decision to scrap the CAS was widely perceived to sparked by a 12.5% drop in the price of HSBC shares in the closing auction on 9 March 2009, after already falling 13.3% in the continuous trading session.
The CAS controversy has centered on the fixed close model that was eventually adopted by the HKEx. In a nutshell, most institutional players had been in favour of a random closing time for the auction, an option viewed negatively by the local stock-broking community.
The model adopted by the HKEx had included an eight-minute order input period (16.00 to 16.08) for normal day trading, and a two-minute pre-order matching period (16.08 to 16.10). Order matching started at 16.10 with the end of the CAS, and securities prices were disseminated to the market within five minutes.
Institutional investors tend to favour closing auctions in principle as it provides them with transparent closing prices for order execution. The problem with the current closing arrangement is that fund managers are unable to buy shares at the closing price because they would not know what the closing price for the day is until the market is officially closed. Often, institutional managers would then have to make adjustments for the difference in the closing price used to calculate net asset values and the price at which the stocks are bought, and this increases their cost.
Most institutional sources feel that any form of the closing auction, even one that is flawed, will be better than the current system for liquidity reasons.