Hong Kong brokers accept closing auction but want lower price limit
After a lengthy debate, Hong Kong stockbrokers have finally accepted the stock exchange proposal to relaunch an auction system to determine stock closing price.
But they are urging the exchange to add more restrictions to prevent manipulation. This is at odds with institutional investors who also want the closing auction to be relaunched but with as few restrictions as possible.
Stock markets in most countries use auctions to set closing prices through tenders by traders, with the most common order becoming the closing price. Hong Kong calculates the median price of the last five orders to determine the closing price, sometimes leading to excessive bidding to influence prices.
Hong Kong Exchanges and Clearing board of directors will on Wednesday decide if the exchange should reinstate the closing-auction session that it shut down after only 10 months of operation in 2009 following charges of market manipulation.
The exchange in January proposed to reinstate the system to keep up with international practice. To mitigate the concerns of brokers, it suggested imposing a 5 per cent price limit for the closing-auction period. Another proposed control measure to reduce price manipulation would involve the introduction of a random closing time so investors do not know when the auction will end.
"The proposed closing auction system has more restrictions than the one scrapped in 2009. It is more acceptable and brokers generally agree the enhanced system should come back," said Christopher Cheung Wah-fung, a broker and lawmaker for the financial services sector.
"But local brokers think the 5 per cent price limit is still too wide and provides room for manipulation. We want the exchange to set the limit at 2 per cent."
Kent Rossiter, head of trading, Asia-Pacific, at Allianz Global Investors, said a 5 per cent closing auction limit should be reasonable in most cases to check volatility at the end of the day.
"A tighter restriction, say of only 2 per cent, would likely result in a much larger number of stocks not being able to reach an equilibrium at the close due to order imbalances between buyers and sellers," Rossiter said.
"Passive fund managers are price takers, so are often more concerned about their order completion than where the actual closing price ends. A closing auction mechanism is expected and is common in larger global markets. This would close one of the gaps that has long troubled institutional investors," he said.
Nick Ronalds, managing director of the Asia Securities Industry & Financial Markets Association, recommends a limit of at least 7.5 per cent.
"Even 5 per cent is an absolute minimum and anything narrower would be counterproductive," Ronalds said. "A 2 per cent limit is definitely too narrow and would have the perverse effect of driving volume out of the close into the pre-close period, quite likely increasing volatility at those times."
Ronalds said the London Stock Exchange and the Deutsche Boerse have no price limits for the closing auction, while others have greater limits. NASDAQ-OMX and NYSE-Euronext have a 10 per cent limit, while it is 15 per cent on the Korea Exchange. The Hong Kong exchange, he said, needs to have a closing auction system to attract institutional investors.
"Passive managers execute most of their orders at the closing price. It gives them near-certainty of execution and also minimises tracking error since passive funds' performance is benchmarked to index closing prices," Ronalds said.
"In the absence of closing auctions, passive investors use a range of alternatives with higher costs and risks, including the OTC (over the counter) markets or other markets altogether."
Hong Kong had adopted the closing-auction system in May 2008 without a price limit but suspended it after heavy selling pressure on March 9, 2009, sent HSBC down 12.47 per cent during the 10-minute auction period. The HKEx then reverted to the previous method of closing.
"Hong Kong is desperately in need of the closing auction and I believe that it's a requirement for any exchange of the size and stature of Hong Kong," said Brett McGonegal, chief executive of financial firm Reorient.
He described the current closing method as "a game of guessing", with multiple players trying to trade a strategy to try to influence the closing price, leading to excessive volatility at market close.
The closing auction, he said, will reduce such volatility at close and all index players will be able to trade at one price at the end of the day.