Little chance of US-style 'flash crash' in HK - yet
with Tom Holland
Ever since last Thursday, when the US stock market nose-dived 5 per cent in as many minutes and then rebounded with equal rapidity (see the first chart), investors have been asking whether such a freak 'flash crash' could hit the Hong Kong market.
Happily, the answer is no - or rather that should be no, not yet.
Most early reports blamed last week's sudden sell-off in US stocks on human error, a so-called 'fat finger' trade in which a trader accidently keyed in an order to sell billions instead of millions of shares. Some commentators suspected deliberate manipulation, and a few even suspected a terrorist attack on the US market.
But as the US regulators have sifted through the 17 million trades struck between 2pm and 3pm last Thursday in an attempt to work out exactly what happened and why, it has become apparent that the likely causes of the slump were more complex - and in many ways even more unsettling.
Clearly a major contributory factor in the sell-off was the enormous changes that have taken place in the US market over recent years. As new technologies have developed, a whole suite of alternative trading mechanisms have emerged to challenge the dominance of the established stock exchanges. Today dozens of electronic platforms offer investors and dealers the chance to trade huge blocks of shares in a matter of milliseconds.
Among the results has been an explosion in volumes - over 10 billion shares in NYSE-listed companies were traded last Thursday, compared with just 600 million during the 1987 market crash.
But recent changes have also led to a fragmentation of the market. Five years ago, the NYSE captured 79 per cent of trades in its own listed stocks. Last year it got 25 per cent. Today its overall market share is estimated at just 15 per cent (see the second chart).
To protect investors, all these different trading venues are connected, with dealers obliged to trade on behalf of clients at the best price available, wherever it is to be found.
Last Thursday it seems one platform experienced technical problems, which led two others to suspend their connections. This caused an abrupt withdrawal of liquidity as high frequency, high volume proprietary trading funds backed out of the market.
As a result, in a nervous market dominated by sellers, stocks gapped downwards as orders to execute at the market price were filled automatically at levels far below their previous prices. Shares in management consultancy Accenture, for example, dropped from over US$40 to trade at just US$0.01, before bouncing back.
No wonder shareholders in Hong Kong are alarmed by the idea of something similar happening here. Yet although the Hong Kong exchange's closing auction has occasionally seen some wild price swings, dealers, exchange officials and regulators insist there is no chance of a US-style flash-crash in our market.
That's partly because the local market is far less fragmented than the US. Alternative 'dark pool' trading venues account for only around 3 to 4 per cent of market volume, according to Securities and Futures Commission chief Martin Wheatley. And even off-exchange trades are subject to rules which limit the size of orders and the extent to which prices can differ from the previous trade.
At the same time Hong Kong's stamp duty discourages high frequency trading while the exchange's technology restricts the number of orders that can be submitted per second.
As a result there is little chance of an abrupt US-style sell-off hitting the local market. 'That particular set of circumstances could not have happened in Hong Kong,' Wheatley declared yesterday. But that doesn't necessarily mean Hong Kong-listed stocks could not suffer disruptive price swings in the future. Alternative trading platforms based offshore are already aiming to capture a portion of Hong Kong's liquidity by offering the same sort of speed and volume capabilities as alternative venues in the US.
'The threat to us is not imminent,' said Hong Kong Exchanges and Clearing chief executive Charles Li, 'but this is a trend you cannot stop.'
He's right. Attempting to protect investors by resisting the onward march of new trading technologies would simply drive trading away to other markets. The best way to ensure a prosperous and orderly market is to embrace the technological changes - and ensure they are properly regulated so no repeat of last Thursday's flash crash can ever take place here.