Closing price uncertainty hits traders on Hong Kong Stock Exchange

Use of median calculated price and restrictions of trading capacity are causing problems for participants on the Hong Kong Stock Exchange

A lack of closing price and restrictions on throughput capacity on the Hong Kong Stock Exchange are making it almost impossible to trade close to the cash market closing price, say equity derivative structurers and execution brokers.

Instead of a closing price, the Hong Kong Exchanges & Clearing (HKEx) trading system takes the last five prints of a stock at 15-second intervals. It then takes the median of these five prints as the closing price and publishes it after market close.

According to one market participant, for ETF providers this can result in a tracking error of several basis points from the actual closing level of an index.

“As there is no closing auction, and the closing price is determined by the five random prints during the last minute, you would have to execute your order at the last minute at those five 15-second intervals to make sure you have the best chance of being close to that median price,” says Glenn Lesko, Asia-Pacific managing director of Instinet in Hong Kong. Instinet is a global agency-only broker owned by the Nomura Group.

According to one head of equity execution services at a bank in Hong Kong, the median price approach results in volatility and higher prices for clients.

“The current calculation mechanism is unstable, as you can see wild swings in prices constantly. There is a huge amount of structured product business that misses the closing price and it is very expensive [for the end-client]. It takes quite an amount of cost [for the client] to ensure that the underlying equities [of the derivative] hit the close,” says the head.

The inefficiency of the median closing price is worsened by the capacity issue relating to so-called throttling fees. The throttle process is HKEx’s control mechanism to regulate the throughput rate for order submissions on the exchange. Imposed on exchange participants as a one-time charge of HK$100,000, the throttle allows one order per second.

Brokers say they face the risk of not being able to complete all trading orders from clients whenever there is a major index rebalance as it is not possible to instantaneously increase throttle capacity.

However, HKEx says the throttle is aimed to ensure fair and orderly operation of the market. It also serves as a reference for HKEx’s capacity planning and management to ensure that the HKEx trading system has sufficient processing power to handle orders submitted by the whole market under peak conditions.

A previous attempt by HKEx to introduce a closing auction in May 2008 was retracted after less than a year in March 2009 – just after HSBC, a major component of the Hang Seng index, fell 20% on a single trading day. Concerns were raised over the possible connection between equity volatility and the closing auction.

According to Gerald Greiner, chief operating officer of HKEx, the exchange suspended the closing auction due to concerns about “any appearance of abuse during the closing auction session on some trading days and the need to maintain public confidence in the orderliness, fairness and transparency of the market in light of [the] then price volatility during the closing auction session”.

Greiner says HKEx would reconsider bring the closing auction back. “However, we do not have a timetable for implementing any of these changes,” he says.