Hong Kong Exchanges & Clearing Ltd., the world’s second-largest stock-market operator, is considering the reinstatement of a closing auction for equities to calm price swings, according to its chief operating officer.
The Hong Kong bourse operator suspended the auctions in March 2009 after large moves at the end of the day spurred concern of price manipulation. Exchanges in most countries use auctions to set closing prices by pooling share orders and finding the level at which the most can be matched.
“It’s clear to most of us here that we need to come up with a better mouse trap, a new way to do a closing auction, because we really do need one,” Gerald Greiner said in an interview. “We need to cover all the concerns there were with the old one.”
Hong Kong Exchanges is trying to regain its ranking as the world’s biggest bourse operator, a title it lost to CME Group Inc., and upgrade its trading systems amid global competition from alternative venues and as large initial public offerings from China slow. The bourse operator has bid 1.39 billion pounds ($2.16 billion) for London Metal Exchange, the world’s biggest commodities market. Greiner declined to comment on the deal.
The closing auction process, shunned only by Hong Kong and Shanghai among the 10 biggest markets worldwide, may reduce volatility and limit manipulation, according to a 2006 paper tracking the introduction of the process at Singapore’s stock exchange. Hong Kong now uses the median price from the final five transactions in a stock to calculate its closing level.
International brokers and institutional investors have been asking Hong Kong to reinstate the auction, saying it lowers volatility and gives them more confidence in the closing price. Deutsche Bank AG in April delivered a survey to the Hong Kong Exchange in April in which its institutional clients unanimously asked for an improved system.
Local independent brokers oppose the auctions, saying they are a manipulation tool for the bigger players, according to Francis Lun, chairman of the Hong Kong Institute of Financial Analysts.
Closing auctions, by bundling all trades into one pool, mean that more capital needs to be deployed to sway prices, researchers led by the Australian National University’s Carole Comerton-Forde said after a study of Singapore Exchange Ltd.
There is no timeline for the reintroduction of an auction, Greiner said.
LME shareholders, led by JPMorgan Chase & Co., Goldman Sachs Group Inc. and closely held Metdist Ltd., are expected to vote on the offer by the end of July. If they approve it, the transaction will be reviewed by the U.K. Financial Services Authority. Hong Kong Exchanges should lose government protections against competition if it begins commodities trading, Hong Kong Mercantile Exchange Chief Operating Officer William Barkshire said in May.
No other bourses or alternative venues may compete with Hong Kong’s main public exchange without government approval, according to the city’s Securities and Futures Ordinance. The only rivals so far allowed have been so-called dark pools, venues that don’t display prices and in Hong Kong exclude retail investors.
The bourse is preparing for competition by upgrading its trading platform and is trying to lure investors to its options business, which Greiner says has been slow to develop despite similarities to its flourishing warrants business.
Warrants are pre-packaged puts and calls created by issuers and sold to investors through the exchange. Using them, retail investors may only buy an option, limiting downside loss to the premium paid. In the options market, investors may buy or sell the derivatives.
While almost 500 brokers may sell warrants in Hong Kong, only about 100 are licensed for the options market, partly because of regulatory impediments, Greiner said. Position limits, or the total amount of options an investor may hold on one underlying stock, are too low, and if brought up to par with U.S. markets, would be as many as 10 times higher, he said.
“We’re always trying to attract the OTC derivatives business to the exchange,” Greiner said. “If our position limits are too low, and the OTC trades are bigger than our position limits each trade, we’re not even on their radar with these levels.”
The Chinese government announced it will encourage joint ventures between the Shanghai and Shenzhen stock bourses and their Hong Kong counterpart, and allow the listing of exchange- trade funds in the city and the mainland, the official Xinhua News Agency said today, citing a statement from the State Council. Foreign investors will also be encouraged to use the yuan in trade settlement and investments in Hong Kong.
China’s efforts to bolster ties come two days before President Hu Jintao visits Hong Kong for the 15th anniversary of the city’s return to Chinese rule on July 1. China has already expanded its RQFII program, which allows the Hong Kong units of financial companies to invest overseas yuan in the mainland, as well as the sale of yuan bonds in the city.
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