Hong Kong’s plan to increase stamp duty by 30 per cent in August will add much-needed revenue to the government’s coffers while helping to drive away dangerous speculative trading activities by high-frequency traders, according to officials and analysts. The city is joining global governments in seeking ways to increase revenue to finance a reboot of struggling economies after the Covid-19 pandemic. Hong Kong and the US, where the stock market performances have outpaced the pandemic-wrecked economies, have become testing grounds for the move. In Hong Kong, even when the city faced the worst economic recession on record last year , the stock market’s average daily turnover rose 49 per cent. Market turnover doubled in the first two months of 2021 while funds raised from new listings surged more than 6.5 times, according to Refinitiv’s data. “Every sector in Hong Kong had been hit hard by the pandemic, except the financial sector,” said the Liberal Party’s leader Felix Chung Kwok-pan, a representative of the textiles industry in the legislature on behalf of the city’s third-largest political party, and an advocate for increasing the stamp duty. Hong Kong’s Financial Secretary Paul Chan Mo-po proposed in his budget last month to increase the stamp duty on stock transactions to 0.13 per cent on the value of the trading for both the buyer and seller, from 0.1 per cent, or a total of 0.26 per cent for each transaction starting on August 1. That means an extra HK$600 (US$77.25) in duties flowing into the city’s coffers for every HK$1 million worth of stocks changing hands. The increased duty will add HK$12 billion in annual income to the government’s coffers, according to estimates. A higher transaction cost may also help to kill the high-frequency trading which now represents about 20 per cent of the cash market trading, a side effect the government does not mind seeing, according to a senior government source. The city is estimated to face a budget deficit of HK$101.6 billion, or 3.6 per cent of gross domestic product (GDP) in the financial year starting April 1, a smaller shortfall than the previous year’s HK$257.6 billion record deficit, according to Chan’s budget. In the US, Oregon congressman Peter DeFazio proposed the Wall Street Tax Act in January to curb the activities of high-frequency traders on the stock market. The plan, pending approval by the US House of Representatives, proposes to place a 0.1 per cent duty on the sale of stocks, bonds and derivatives, or US$1 for every US$1,000 of trading, aimed to raise US$777 billion in new revenue over 10 years. Italy in 2013 introduced a tax on high-frequency trading which was followed by France later. “The stamp duty will increase much-needed revenue for the government and I don’t think this modest increase will hurt the market,” said the former Secretary for Financial Services and the Treasury Chan Ka-keung, now the chairman of virtual lender WeLab Bank and a staunch defender of the tax on equity transactions. “The stamp duty is an important source of income for the Hong Kong government, and we don’t tax dividends and capital gains. Some high-frequency traders argued to eliminate the stamp duty but I questioned whether this brings any benefit to the overall quality of our market.” Over the past decade, the stamp duty on stock transfers has been an important source of government revenue, contributing between HK$20 billion and HK$37 billion each year. It represents 5.7 per cent to 8.8 per cent of the government’s operating revenue during the period, government data showed. “There is a lack of sympathy for high-frequency trading in Hong Kong,” Charlies Li Xiaojia, the former CEO of HKEX, told a virtual conference organised by Swiss bank Credit Suisse on Monday. “The traders most impacted by an increase in stamp duty are HFTs. We are losing a lot of quantitative trading, who otherwise would find Hong Kong a good place to trade.” He hoped that this was not a permanent phenomenon and that it would be reviewed at some point when volume is high, and the economic recovery takes place and the pressure on funding eases. “It is more difficult to reduce taxes than increase taxes,” Li said. In high-frequency trading, traders use computer programs to hold short-term positions in stocks, futures and other financial products and make money off the smallest market movements by buying and selling repeatedly within milliseconds over the course of the day. This type of trading can boost trading volumes. Nearly 10 billion shares change hands everyday on the New York Stock Exchange, compared with just a few million during the 1980s. Since there is no tax on transactions, high-frequency trading can be profitable. In Hong Kong, high-frequency traders tend to zoom in on warrants and derivatives such as callable bull/bear contracts and Exchange Traded Funds (ETFs), as these financial products are typically duty-free. While these algorithm-driven trading widens the financial liquidity of the capital market, they exacerbate volatility during times of stress. Any rise in transaction costs on securities without a corresponding increase for warrants and derivatives will naturally drive traders to these financial products, which will still provide ample room for high-frequency traders to maintain their activities, said Tom Chan Pak-lam, chairman of the Hong Kong Institute of Securities Dealers, an industry body of local brokers. “As a free market, it is natural for Hong Kong to have short-term traders and market volatility,” he said. High frequency trading can wreak havoc, as shown by history. On May 6, 2010, the Dow Jones Industrial Average plunged by nearly 1,000 points, or 9 per cent, in around 36 minutes. Though the benchmark recouped most of the losses on the same day, the “flash crash” wiped out an estimated US$1 trillion in value from the world’s largest financial market. Hong Kong’s market had a close shave the next day during Asia trading hours, with the Hang Seng benchmark plunging by as much as 2.2 per cent, before ending the day with a 1 per cent deficit. The problem is made worse because Hong Kong’s “light-touch” stock market operates with very few brakes or circuit breakers, which explains why a stock like Apple Daily ’s publisher Next Digital could soar by up to 1,200 per cent in two days last August. After the flash crash, a raft of circuit breakers were rolled out in New York over a six-month trial period to halt transactions for five minutes in any S&P500 stock that rises or falls by more than 10 per cent over a five-minute interval. A similar curb, known as a Volatility Control Mechanism (VCM), was rolled out in June 2016 to impose five-minute cool-off periods on constituents of the benchmark Hang Seng Index. Still, the VCM does not apply to non-Hang Seng stocks like Next Digital. Volatile stock markets, exacerbated by the estimated US$8 trillion of global liquidity unleashed by global central banks amid the coronavirus pandemic, are raising concerns among financial regulators. In January, armies of day traders and amateur investors swarmed zero-commission brokerage platforms such as Robinhood, egged on by chat groups on social media networks such as Reddit to buy shares of GameStop and AMC Entertainment Holdings, in defiance of short-sellers in the so-called “nerds vs Wall Street” battle. Shares of GameStop, a left-for-dead speciality games distributor, jumped almost 50-fold from last year’s average US$7 per share to a January 27 record of US$347.51 before crashing to US$90 over four trading days. It closed at US$208.17 on March 17. The frenzy over GameStop reminded Hong Kong’s regulators all too uncomfortably of the Next Digital saga last year, when 15 people were arrested on suspicion of conspiracy to defraud and money laundering by manipulating the company’s shares. Hong Kong’s legislature is expected to put the financial secretary’s proposed stamp duty increase to a vote in May, which could pave the way for the duty to take effect on August 1 . If the proposal passes, as it is expected to, it will make Hong Kong the world’s second-most expensive capital market for transacting a securities trade, behind only Britain’s 0.5 per cent duty. “Hong Kong’s stock market turnover may decrease as a result of the duty increase, driving some companies to opt for listing in other markets,” said Christopher Cheung Wah-fung, the chief executive of Christfund Securities, who represents the financial services sector in the city’s legislature. The impending stamp duty has affected the shares of Hong Kong’s market operator, which are listed on the city’s bourse. Shares of Hong Kong Exchanges and Clearing Limited (HKEX) fell by more than 20 per cent since the financial secretary’s February 24 budget announcement. Average daily market turnover fell 43 per cent from a record HK$354.33 billion on February 24 to about HK$200 billion this week. Still, not everyone thinks Hong Kong’s stock market will wither from the stamp duty, not least the hundreds of companies waiting in the queue to raise funds in the world’s top IPO destination for seven of the past 12 years. Baidu, the Chinese internet search engine, raised more than US$3 billion in a secondary listing in Hong Kong this week, while the video site Bilibili is seeking to raise up to US$3.2 billion. A total of 27 stock sales this year have raised a combined US$3.91 billion, a sixfold increase from the same period last year, according to Refinitiv’s data. “The proposed stamp duty increase will have minimal impact on the Hong Kong IPO market and also the overall market turnover,” said Christina Lee, a partner at Baker McKenzie’s Capital Markets Practice Group in Hong Kong, adding that the global trend is either to maintain, or raise transaction duties, not abolish or cut them. Hong Kong’s government, which has been mandated to collect stamp duties since 1866, first cut the transaction tax in the stock market in 1978 from 0.8 per cent to 0.6 per cent, shared equally between buyers and sellers. That was further whittled down to 0.3 per cent between 1991 and 1993. From Hong Kong’s handover in 1997 to 2001, authorities cut the duty three more times. During that period, the Hang Seng Index surged 174 per cent from a bottom to the peak, and fell 51.2 per cent from crest to trough, for an overall 6.6 per cent gain, according to Everbright Sun Hung Kai’s strategist Kenny Ng Lai-yin. “This shows that the stamp duty has no impact on the performance of the stock market, which is more affected by overseas markets performance and other factors,” Ng said.