The reinstatement of Hong Kong’s closing auction is not a foregone conclusion. There is a clash between local interests and those of bigger market players and the organisations that represent them.
In mid-January, Hong Kong Exchanges & Clearing (HKEx) announced a three month consultation concerning the possible reinstatement of the Hong Kong market’s closing auction.
“We believe it is high time to get a closing auction in Hong Kong. There’s absolutely no question about that. The case for reinstatement is extremely powerful,” said Nick Ronalds, the head of equities at the Asia Securities Industry & Financial Markets Association (ASIFMA). “It’s something we’ve been desperately wanting for years now. It is near scandalous that Hong Kong is the only developed market exchange that does not have a closing auction. They are very effective mechanisms for promoting liquidity, and that is so important for investors timing executions for the close – as their benchmarks are usually based on end-of-day prices.
Beyond the bookkeeping aspects, he considers that markets with closing auctions are less volatile, as suggested by empirical data which shows that on important rebalancing days almost half of daily volumes can take place at the close.
The backdrop to the consultation is not one of unanimous support to reinstatement.
A number of local brokers are resisting change, and their preference to inertia is being expressed through their securities associations and their representative on Legco.
A number of smaller brokers are thought to be keeping their exchange seats merely in the hope of being bought out, and are doing very few trades. They do not want to spend money on technology upgrades and feel comfortable with the current system.
Their relationship with top brass at HKEx is rumoured to be a frosty one and they also have a suspicion that a new closing auction might see a repeat of the 2008 situation that caused its previous abolition – a large institution which caused significant volatility (in the share price of HSBC).
Matt Saul of Asia Pacific, Fidelity Worldwide Investments, speaking in his capacity as chairman of the Asia Traders Forum, said that his buy-side group strongly supported the renewed effort to implement a new closing auction, “to replace the current inefficient process, allowing the local market to at least match its international peers,” he said. “No doubt there will be suggestions for further improvements once both changes are introduced and we will continue to work with the HKEx to progressively adapt the model to suit the needs of all investors in the Hong Kong market.”
HKEx has devised an auction proposal that starts at 4.01pm, when 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. Then, 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.
The local industry is giving the sense that if the auction is reinstated, they would require that proposed 5% range to be narrowed. ASIFMA is opposed to such a foreshortening of the range, considering that the allowable band needs to be wider, because, in practice a smaller one causes more volatility going into the close. The NASDAQ, for example, has a 10% band in its auction.
The random closing from 4.10pm to 4.12 pm would reflect a lesson learned from other closing auctions. That helps to make auctions more resistant to gaming. In early incarnations, there was a fixed time when the auction would take place, large orders might appear microseconds before the auction would take place and skew the price.
“In Hong Kong the two minute period in which the closing auction would take place at a random time constitutes a major anti-gaming mechanism,” said Ronalds.