Auction periods need to be re-examined
A massive sell-down in HSBC shares in a single transaction just before the end of the closing auction session on Monday has understandably shocked many investors. It is the latest example of how the controversial auction period can be open to abuse and manipulation. The extended 10-minute period after the trading session closes at 4pm is supposed to make pricing fairer and manipulation more difficult. Instead, good intentions have, in practice, led to undesirable consequences. This trading experiment needs to be overhauled.
Almost from their introduction in late May, the auction periods have frequently seen wild swings in share prices and sudden surges in transaction volume. Price movements have been as high as 20 to 30 per cent from the indicative prices at 4pm. The concentrated volume of trading during closing auctions offers price-fixing opportunities for large fund managers and hedge fund operators who can execute large orders at a fixed price, but it puts retail investors at a disadvantage or simply pushes them out of the game.
After much criticism, Hong Kong Exchanges and Clearing has now beaten a retreat. Originally, it said it would start limiting share price changes to no more than 2 per cent in either direction during the closing period - but only in June. The exchange said the time was needed for brokerages and financial firms to make adjustments. But this would simply prolong unfair as well as unnecessarily volatile last-minute trading for a few more months. Thankfully, the exchange has decided to accelerate the implementation of the 2 per cent cap on share-price fluctuations. Financial Secretary John Tsang Chun-wah yesterday expressed concerns about the incident, and the Securities and Futures Commission has launched an inquiry.
The price cap rule should be introduced as soon as possible, but it is not a panacea. Indeed, it only pushes back the problem of price-fixing that led to the introduction of the auction period in the first place. Regulators who came up with the 10-minute extension were originally concerned about market manipulators pushing stock prices artificially up or down shortly before the 4pm closing. With a 2 per cent cap, a manipulator who does his trick before 4pm can be sure no one can move against him by more than 2 per cent. So the cap will moderate price-fixing, but does not resolve the problem.
Another rule used in some overseas markets is to make the length of the closing auction session random, so would-be price-fixers would not know whether they have the full session or a much shorter time. This would make it cost-prohibitive to try to manipulate the closing price. But in a place like Hong Kong, concerns will inevitably be raised about the danger of insiders learning each day's closing time. Therefore, each of these rules, considered before and during the exchange's consultation late last year, has its drawbacks. For a quick fix, the 2 per cent cap should work. But for the future, the whole closing auction period needs to be re-examined.