Hong Kong Stock Exchange

HKEX says new market circuit breaker designed on ‘light-touch’ principle

PUBLISHED : Thursday, 02 June, 2016, 9:25pm
UPDATED : Thursday, 02 June, 2016, 11:07pm

Hong Kong’s stocks circuit breaker, slated to be introduced in August, has been engineered for a “light touch” such that it will help calm markets while assuring investors of continuing liquidity and turnover, according to officials.

They added that the approach taken is different from that of the ill-fated circuit breaker mechanism introduced in Shanghai earlier this year.

Hong Kong Exchanges & Clearing (HKEX) will launch a Volatility Control Mechanism (VCM) on August 22, which is designed to temper stock movements by temporary halting trade when prices fluctuate beyond a pre-determined range.

“The VCM is quite different from mainland China’s circuit breaker,” HKEX’s Head of Market Operations Roger Lee said. “The chance is small that it will lead to similar scenes in Hong Kong markets.”

He added that the exchange planned to re-introduce a daily Closing Auction Session on July 25 after a seven-year absence, as part of changes to help reduce volatility of closing prices.

China implemented a circuit-breaker system on January 4, but suspended it after only four days of operation as the mechanism ignited downward pressure on stocks and stoked fears about the health of the markets.

Lee said the VCM is not intended to suspend trading or limit price movement of individual stocks, but instead to offer a temporary cooling-off period and prevent drastic events such as algorithm errors and “flash crashes” which may cause systemic risks.

Under the proposal, a five-minute cooling-off period will kick in if the price of a stock swings by over 10 per cent from the last trading price 5 minutes earlier, or when the price of a futures contract moves by over 5 per cent.

Nevertheless, investors can still trade the security or contract within a band during the cooling-off period, after which normal trading will resume.

The cooling-off mechanism will apply to 81 constituent stocks of the Hang Seng Index and the Hang Seng China Enterprises Index and eight related index futures contracts.

The VCM can only be triggered two times a day for an individual stock or contract, one in the morning session and the other in the afternoon trade, Lee said.

The VCM will apply for the first 15 minutes of the morning and afternoon session, in addition to the final 15 minutes before the close of trade.

“It’s a simple and light-touch approach to balance market protection and trading with no limits,” Lee said. “Perhaps the lightest touch among all similar approaches adopted by major stock markets.”

The introduction of CAS is aimed at curbing volatility of closing prices, as the volatility may lead to higher tracking errors for index funds.

Most developed and emerging markets already use a closing auction, he said.

HKEX launched a closing auction in May 2008, but scrapped it in 2009 after the system was blamed for exacerbating price fluctuations.

Lee said the new CAS, which has a 10-minute trading session, will calculate a reference price based on the median of 5 nominal prices in the last minute of the afternoon session. During the first five minutes of the session, the price limit of orders should be 5 per cent up or down from the reference price. After that, the price range will be further narrowed between the lowest ask and highest bid.

He said the new CAS could increase the costs for potential market manipulators and make it easier to identify these activities.