THERE is nothing new about the alarm bells ringing over stock futures in Hong Kong, and the futures exchange is now determined to silence them. In August 1928, the United States Congress was so concerned about the effect that trading in onion futures was having on the spot onion market that it banned the instruments under the Onion Futures Act (Public Law 85-839). For this welcome perspective on the arguments now raging in Hong Kong, we thank Andy Kan Chi-nam of the Department of Finance and Decision Sciences at the Hong Kong Baptist College. Mr Kan has produced a timely paper on the effect of futures trading on the Hang Seng Index, and looks particularly at the effect on its constituents. Those who really want to understand what futures might, or might not, mean for Hong Kong's securities market should study both Mr Kan's conclusions and the consultation document issued yesterday by the Futures Exchange. Mr Kan is, presumably, agnostic. The futures exchange would have to admit to having a vested interest in the launching of individual stock futures in Hong Kong, so it might be a teeny bit biased in its approach. Mr Kan has no axe to grind, and approaches the subject with cold, academic logic - and quite a lot of algebra. The exchange's paper appears to assume that even the members of the professional bodies at which the paper is aimed are unfamiliar with the concept of futures. And judging by some of the more spectacular comments which have been made, it is probably right. The purpose of the exchange's question-and-answer based publication is to convince the influential that: a) Hong Kong needs this instrument if it is to stand up as an international finance centre, and; b) It poses no threat to the underlying market. To make its point that stock futures contracts do not increase volatility, the futures exchange mentions in passing that this view is supported by academic research. This shows, it says, that there has been no evidence of increased volatility, and that it could even be reduced. Mr Kan's findings certainly lean towards this thesis. His research stretches to both sides of the introduction of Hang Seng Index futures on May 6, 1986, and covers the period from May 1983 to May 1989. The Crash of '87 has been erased to avoid distortions. Nor does it cover the recent arrival of the big American houses and their capital-intensive transactions in the futures market. If Mr Kan turned his attentions to their activities and the effects on the Hang Seng Index, he might have a bestseller on his hands. One of his main findings is that the existence of this futures market has no measurable effect on the volatility of the index. One point to the futures exchange. But Mr Kan cannot conclude that such trading will stabilise prices in the long run, although the immediate effect of their introduction was for less volatility. Over a longer period, outside influences are likely to overwhelm any steadying effect of the futures. Half a point to the critics. Significantly, given that the two pioneer stocks will be the biggest capitalised companies on the market - HSBC Holdings and Hongkong Telecom - it was the big cap stocks that were thrown around most in the early days of futures trading. This might have been a result of the relative inexperience of the players, or 'uninformed speculators' as Mr Kan describes them. What the futures exchange should be aware of is the need to choose additional members of the futures party carefully. It should be especially wary of the 'family effect'. Earlier studies showed that prices of family-controlled index constituents tended to move together more than those of stocks controlled by different families. Changes in one company identified with a big family or other controlling group tend to move in unison, and volatility is passed on from one to the other. So officials should perhaps be slower to choose from the Li Ka-shing stable, or the Kadoorie Stable, for when Hang Seng Index futures were introduced, their volatilities increased significantly. This was thought to be another example of 'uninformed noise' and not a universal effect. Shares in companies controlled at the time by Lee Shau-Kee and his family, and by Y K Pao, reduced in volatility. Those of companies controlled by the Keswicks remained unchanged but, given the shift in listings of the Jardine group, this really is of academic interest.
