Hong Kong Exchanges & Clearing will consult this year on reinstating a closing auction for the cash equities market, a much-sought-after mechanism that is thought to dampen trading volatility and help fund managers reduce portfolio tracking error.
Hong Kong is the only one of the 23 MSCI developed markets where the closing price is not determined by a closing auction. In May 2008 it introduced one, only to retract it in March 2009 after HSBC, a major component of the Hang Seng Index, fell 20% on a single trading day. Concerns were raised over the possible connection between equity volatility and the closing auction.
After many years of industry debate, there is no question that a closing auction is necessary, says Gerald Greiner, HKEx's head of global clearing. The question now is how to determine on the right mechanism for Hong Kong, with one possibility being to impose a cap on stocks during the auction period, he tells AsianInvestor.
HKEx also plans to consult on other proposals, such as circuit breakers (as seen in other markets such as Singapore) and pre-trade risk limits, with the aim of preventing aberrant algo-driven orders or ‘fat finger’ errors from disrupting the market.
But Greiner says the exchange will give priority to the closing auction plans this year, which appears to be the clearest timetable that HKEx has provided for its re-implementation.
While Japan, Singapore and Taiwan all have a closing auction, Hong Kong bourse’s closing price calculation mechanism is a headache for many brokers and asset managers. It takes the last five prints of a stock at 15-second intervals, using the median as the closing price, which it publishes after close.
This calculation method has created wild price swings and volatility in stock prices close to the market close. This is a particular issue for managers of index and exchange-traded funds, because it means they struggle to reduce tracking error when seeking to trade near the close.
Both brokers and buy-side firms have been in touch with the HKEx over the past year to push for a closing auction mechanism that would limit large price moves during the auction period, says Gabriel Butler, head of electronic trading sales for Asia ex-Japan at Morgan Stanley.
It appears that HKEx does aim to introduce a “cap”, as mentioned by Greiner, in the sense of a specific percentage range around a benchmark price, say industry players. The aim would be to prevent big price swings caused by large orders sent immediately before the end of the order matching period, they add.
The consultation will seek to gauge market participants’ view on which benchmark price to use – for example, a stock’s last traded price – and the size of the trading range.