It's good to be back after the Chinese New Year break. At HKEx we are excited to begin the Year of the Horse.
We are starting the year after a strong finish to the Year of the Snake. Our markets showed great resilience over the last year, finishing second in IPO funds raised and setting turnover records in ETFs and several derivatives contracts. Our subsidiary the London Metal Exchange also saw record trading volumes. But as I’ve argued before, we can't be complacent. We’re in a fast-paced industry with nimble competitors, so we need to remain focused on ensuring our market is as competitive as it can be while maintaining high risk management and investor protection standards.
I've been asked about a variety of topics over the past few weeks, many of them related to market microstructure. The question of circuit breakers, in particular, has drawn quite a bit of interest from the market, and people have been forthcoming in expressing their opinions, which I think is a good thing. I would like to share some of my thoughts on the subject.
First of all, what are circuit breakers? A circuit breaker is a mechanism whereby in case of extreme and abrupt price volatility that moves prices beyond a pre-set threshold in a very short space of time, a pause is triggered in the trading of the security or group of securities concerned, or of the market as a whole. The objective is to give the market a chance for reflection so as to avoid a panic reaction to a price movement that is unrelated to a change in fundamentals – for example, a faulty algorithm, or a 'fat finger' order. During the pause, depending on the design of the circuit breaker, trading may or may not continue within certain limits; following the pause normal trading resumes, and the circuit breaker trigger is reset to a new level.
Our market has discussed circuit breakers from time to time before, with the conclusion being that they weren't necessary. Some people say that circuit breakers are not suitable for our market and amount to market intervention, therefore are a waste of time to consider. But I don't think that previous decisions necessarily apply to evolving market conditions today. The Exchange has to maintain a fair and orderly market – this is in fact our statutory duty – and we have to stay alert continuously for changes that may require new mechanisms to maintain market integrity.
In normal market conditions, investors find the right price for a security of their own accord without intervention from the market operator. But in recent years the proliferation of computers has changed the way trading is conducted in almost every market, including our own. Trading has become much faster than it was a decade ago, and it's often done automatically via algorithms that have a chance, even if a remote chance, of generating erroneous orders which could create an overraction and threaten market integrity. Of course, this overreaction would eventually correct itself, but perhaps not before considerable turmoil which could impact confidence in the market. We have seen such cases in overseas markets, and we have to ask ourselves whether they could occur here in Hong Kong.
Some market participants have told us that they are concerned about the adequacy of the measures to safeguard the Hong Kong market against disorderliness caused by human and machine error. Indeed, this area is one that the International Organisation of Securities Commissions (IOSCO) has asked markets to review, and the SFC's new electronic trading regulations which became effective early this year push in the same direction. I think it is timely for a renewed debate on circuit breakers to determine if they are now needed in the Hong Kong market.
So that's why we're looking at circuit breakers again. I would also like to clarify some misperceptions that I have heard expressed about circuit breakers by some market participants.
One perception is that the Exchange wants to introduce circuit breakers in order to align Hong Kong with the Mainland exchanges. However, aligning with the Mainland is not the objective. The objective is first to consider whether there is a need for circuit breakers in Hong Kong, and if there is, to develop a circuit breaker mechanism that is suited to our market's specific needs.
Another misperception is that circuit breakers mean strict daily price limits as in the Mainland and some other Asian markets. However, this is not necessarily the case. Many overseas markets have circuit breakers with thresholds that are not fixed but adjust dynamically with market movements, allowing price discovery to take place more normally. The key point is that if we are to introduce circuit breakers here, we’ll have to find a model that suits Hong Kong best.
A third perception is that circuit breakers are the same as trading suspensions. Again, that is not necessarily the case. There are circuit breaker models used by other exchanges that provide a short "cooling off" period (usually of a few minutes) during which trading continues to take place subject to certain conditions such as a limit on the price at which orders may be executed.
In my view, any introduction of circuit breakers in Hong Kong would have to meet the following conditions.
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They should mitigate the risk of extreme and abrupt market volatility caused by non-fundamental factors (such as faulty algorithms);
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They should safeguard the integrity of the market; |
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They should be flexible enough to allow for fundamentals-driven price movement; and |
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They should be straightforward enough for our market participants to understand and implement. |
This is not an easy list of conditions to meet, and we certainly need extensive discussion and debate in the market to arrive at a conclusion.
As yet the discussion is only beginning. At the Exchange we have not come to any conclusion as to whether there is indeed a need for some kind of circuit breaker for our market and, if so, what kind. Any decision would only be made after we have sufficiently consulted the market and the various views are thoroughly considered. Some people may feel passionately one way or the other; but until we are able to provide a forum through the consultation process where all views and opinions can be heard, debated and carefully considered, we will not be able to make the best decision for our markets. So please be patient and ready to contribute your views as well as be willing to hear other people's views.
I should also say that studying circuit breakers is not the only item on our strategic agenda this year. In addition to other new business initiatives, we are looking at ways to strengthen our established businesses.
We recognise that any new measures will not be without challenges as market participants may have different interests at stake. We will therefore consider participants' views carefully. Where we decide to proceed with new initiatives, we will consult the market comprehensively; if the initiative is supported by the market, we’ll implement it in an appropriate manner, giving the market time to prepare and adjust. We will also do our best to explain any new measures, so that they are well understood by Exchange Participants and investors.
When we consult on these strategic issues, I encourage everybody in the market to share their views with us. By working together, we can further enhance Hong Kong’s competitiveness and continue our momentum in 2014.
May you have a very healthy, happy and prosperous Year of the Horse!