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Hong Kong Stock Exchange Looks To Control Volatility

by Mary Swire, Lowtax.net, Hong Kong
20 January, 2015

Hong Kong Exchanges and Clearing Limited (HKEx) has published a consultation paper on the proposed introduction of a Volatility Control Mechanism (VCM) for its securities and derivatives markets and the introduction of a closing auction session (CAS) for its securities market.

HKEx believes that the VCM is needed to preserve market integrity in its securities and derivatives markets, in line with regulatory guidance from the International Organisation of Securities Commissions and global trading practice. Meanwhile, the CAS is needed to enable trading at securities' closing prices, a change which many brokers and investors have been requesting for some years. More generally, the moves are intended to enhance the exchange's global competitiveness.

"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" in the United States on May 6, 2010, when the Dow Jones Industrial Average fell by almost 1,000 before an immediate rebound, global regulators have 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.

In that regard, the proposed VCM would cover the 81 constituent stocks of the Hang Seng Index (HSI), the Hang Seng China Enterprise Index (HSCEI), and the spot month and next calendar month index futures contracts for the HSI and HSCEI, plus their respective mini futures contracts.

The trading of the instruments covered would be monitored against a dynamic price range. If prices for stocks were to change rapidly by ten percent in either direction, or by five percent for futures, there would be a five-minute cooling-off period on trading within a fixed price range to allow market participants to reassess their strategies and reset algorithm parameters (for those making automated trades).

With regard to the proposed CAS, it was pointed out that all developed markets except Hong Kong have such mechanisms in place to enable trading at the closing price, which some institutional investors, index trackers, and pension funds include in their mandates.

A two-phased CAS rollout is proposed. Phase 1 would cover the most liquid securities index constituents and related exchange-traded funds. When the market is familiar with the new mechanism, the CAS would be expanded to all remaining equity securities and funds.

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