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Hong Kong rejoins developed market bourses with closing auction

[HONG KONG] Hong Kong is going to rejoin its developed market peers when it reintroduces a stock-market closing auction after a seven-year gap.

Hong Kong Exchanges & Clearing Ltd plans to start the system on July 25, it said Friday. Two market rehearsals are planned in May and June. HKEx scrapped its previous auction mechanism in 2009 after HSBC Holdings Plc saw its shares plunge about 10 per cent in the final seconds of the day. The new system comprises a 10-minute trading session and was designed after HKEx officials reviewed about a dozen of their global peers.

The city's US$3.9 trillion stock market is the last of 22 global developed nations without a closing auction, a mechanism particularly favored by index-tracking funds because of the stability it can bring to end-of-day prices, which they rely on.

Not only do officials at Hong Kong's market believe they've taken the best ideas from countries including the UK, Germany and Australia, they also claim their new offering will reduce opportunities for manipulation. Hong Kong currently derives closing prices in the last minute of trading, a practice used in Hungary, Bahrain and Colombia.

"One benefit of others doing it before us is that we've been able to learn from their experiences and incorporate the best elements," Roger Lee, head of markets at the exchange, said in an interview.

The new model will limit price moves and allow the market to close randomly in the final two minutes to deter gaming. Restricting order amendments and cancellations will also discourage price manipulation, according to the exchange.

The system needs to avoid the troubles of HKEx's first closing auction, which was pulled after a March 9, 2009 incident that saw HSBC's shares plummet. The bank's stock was already down 15 per cent that day amid general volatility and concerns about deepening loan losses in the US, when the decline was exacerbated by trades in the final seconds of the closing auction and the shares ended down 24 per cent.

"They had a bad experience when they adopted a closing auction some years ago, but the new model has very significantly improved," said Nick Ronalds, the managing director for equities at the Asia Securities Industry and Financial Markets Association.

Trading during the closing session could account for as much as 15 per cent of average daily volume, according to Societe Generale SA's estimates. On a day indexes rebalance, that could rise to almost one-third of daily volume, according to the Hong Kong exchange's own estimates.

"The goal of this auction is to maximize liquidity in fixing of the closing price," said Stephane Loiseau, head of cash equities and global execution in Asia-Pacific at Societe Generale.

Mainland China's stock markets don't have closing auctions. On the Shanghai Stock Exchange, the closing price is the average price of all volume-weighted trading conducted one minute before the close, while on the Shenzhen Stock Exchange, it's generated through call auctions.

HKEx's auction will calculate a reference price that will set a 5 per cent up-and-down trading limit for five minutes. The pricing boundary could be further narrowed between the lowest ask and highest bid and the stock will then close any time in the last two minutes of the 10-minute auction, according to an HKEx presentation.

"The market has been desperately crying out for it for a long time," said Neil McLean, head of trading for Asia ex-Japan at Instinet Pacific Services Ltd in Hong Kong.

BLOOMBERG