Gap narrows as spread debate ends
Key decision keeps smaller brokers happy while bigger peers seem content with compromise, writes Enoch Yiu
The stock exchange's final decision on the trading spread reform last week is likely to make retail investors and day traders focus on stocks trading at less than HK$2 and keep smaller brokers afloat, market watchers said.
A two-tier market may also be formed since larger investors could concentrate on more expensive stocks with narrower spreads, particularly for their hedging needs.
By leaving the spread - the gap between the bid and ask prices - unchanged for low-price stocks, retail investors and day traders who tend to bet on bigger price movements could continue to find their niche while avoiding stocks at HK$2 or more, on which the spreads have been cut.
'It is a good move to let the spread trading under HK$2 remain unchanged as retail investors including day traders like to trade at a wider spread,' said Joseph Tong Tang, executive director and chief executive of wealth management, capital markets and brokerage at Sun Hung Kai Financial. 'Day trading activities of warrants and stocks may well reach about 40 per cent of total market turnover.'
The 13-year debate on trading spread reform ended on February 14 with the board of Hong Kong Exchanges and Clearing deciding against narrowing spreads for stocks below HK$2.
The spread controversy, which pitted large brokers against their smaller rivals, has waxed and waned since 1994. That year, the exchange ordered a narrowing of spreads for stocks trading below HK$10 but retail brokers and investors forced it to back down.
The subject re-emerged early this decade when the trading system became more computerised and institutional investors wanted narrower spreads to make hedging easier at the prices they wanted. However, small brokers, whose income relied on day trading activities of retail investors, still preferred wider spreads.
Nevertheless, in July 2005, the exchange cut the spreads of 36 stocks trading above HK$30. It went even further in February last year by cutting the spreads of all stocks trading at less than HK$20, leaving just those between HK$20 and HK$30 unaffected.
After staunch opposition, the exchange compromised in June last year by exempting shares trading at less than HK$2 from the narrower spreads. That decision came up for review this month.
The stock exchange's board decided to uphold the exemption, resulting in a substantial gap of trading spreads between large and small stocks.
For example, the spread of a stock trading at 50 HK cents has a 2 per cent spread, 10 times wider than the 0.2 per cent spread of a stock trading at HK$5.
David Webb, the only exchange director who voted for changing the spread for stocks under HK$2, said this gap was 'ridiculous'.
But from the brokers' point of view, the decision was vital to save their last piece of fat meat.
A exchange director said most directors who agreed not to proceed with narrowing the spreads for stocks below HK$2 did so to meet the demands of local brokers.
'There is no clear evidence that narrowing trading spreads would attract much more turnover from international investors or large brokers. These low-priced stocks are not the cup of tea of the large traders, anyway,' he said.
'The small players said more of them would go out of business if the exchange went ahead with the plan. There is no harm in keeping the spread for these low-priced stocks unchanged.'
Large brokers seem untroubled by the decision.
Daniel Hegglin, Pan-Asia head of the Consolidated Equities Division of Morgan Stanley, said: 'We are not that concerned as this is not the market segment we cover, but we do think a 2 per cent spread is excessive.'
However, some critics saw political forces behind the decision.
All four government-appointed HKEx directors who attended the board meeting voted for no change, which came one week after all 12 brokers representatives in the Election Committee as well as lawmaker Chim Pui-chung, who represents the brokerage industry, vowed to support Donald Tsang Yam-kuen for re-election as chief executive next month.
'I can't help but notice that small brokers have 12 seats on the Election Committee which is about to elect the chief executive. It's a classic demonstration of what is wrong with our political system,' Mr Webb said.
Mr Chim had said that he would lead a rally if the exchange decided to narrow the spread of the shares trading below HK$2.
'This is not a political exchange,' Mr Chim said last week. 'The decision is a win-win situation for both large and small investors. The trading spread above HK$2 has been narrowed so institutional investors who need hedging have got what they wanted. Retailer investors, particularly day traders, would like to keep the spread unchanged and they are now happy,' Mr Chim said.
Unsurprisingly, local brokers welcomed the exchange's decision.
Vincent Lee Kwan-ho, an HKEx director of a small brokerage and chairman of the Hong Kong Institute of Securities Dealers, said a review of trading activities over the past six months showed that narrower spreads on more expensive stocks discouraged retail investors from day trading and reduced small firms' commission earnings.
The smallest brokers now have just 11 per cent of market share, compared to more than 50 per cent for the top 40 firms.
'This decision will give retail investors and local brokers room to trade these low-priced stocks and will not affect the overall market,' Mr Lee said.
Mr Chim said the decision would achieve a more balanced market by keeping the small players.
'For Hong Kong to be an international financial centre, there should be large, medium and small brokers. Both institutional investors and small retail investors have the right to trade in the local market,' Mr Chim said.