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Hong Kong stock exchange to introduce volatility controls from mid-2016

[HONG KONG] The operator of Hong Kong's stock exchange said it will introduce new controls to rein-in volatility, in a long-awaited announcement that comes as Chinese shares see wild price swings, fueling fears of a mainland market collapse.

Hong Kong Exchanges & Clearing (HKEx) said on Friday that it will proceed with a proposal, unveiled in January, to introduce a so-called closing auction and other volatility curbs that would bring it in line with international peers in New York and Europe.

HKEx said it will give the market a year to prepare for a phased implementation of the new controls, with the roll-out beginning from mid-2016.

The exchange had held off on reintroducing a recalibrated closing auction for several years amid opposition from influential local retail brokers who claimed the mechanism could give rise to market manipulation.

On Friday, however, the HKEx finally bowed to overwhelming pressure from international investors who say the measures are critical to Hong Kong's status as an international financial centre.

The HKEx has come under intense scrutiny in recent weeks following a series of jaw-dropping moves that saw stocks such as Hanergy Thin Film Power Group and Goldin Financial Holdings lose up to 50 per cent of their value in less than two hours.

Chinese shares listed in Hong Kong had surged earlier this year along with a sizzling speculative rally in mainland markets, which more than doubled over the last year. But mainland shares have plummeted some 30 per cent in recent weeks, pulling down Hong Kong's China Enterprises Index by more than 10 per cent.

All major stock exchanges use an auction at the end of the trading day to reduce volatility when calculating closing prices. Buy and sell orders are pooled during a five- or 10 minute period and are then matched at the best available price.

In Hong Kong, the closing price is based on continuous trading, whereby orders are matched immediately.

According to research by State Street Global Advisors published in 2012, volatility in Hong Kong during the closing period can be as much as six times greater than in other developed markets.

The HKEx launched a closing auction in May 2008 but scrapped it 10 months later after design flaws actually exacerbated price swings. "We are pleased that the majority of respondents from the various market segments supported the implementation of the two market microstructure reforms, which will put us on par with other leading exchanges," said Roger Lee, HKEx's head of market operations, in a statement.

Many major exchanges, including the New York and London bourses, try to mitigate such swings through so-called circuit-breakers that temporarily suspend trading in a stock if it behaves erratically. The HKEx plans to introduce similar controls that will restrict a stock to a trading price band.

In a statement, Sally Wong, chief executive of the Hong Kong Investment Funds Association, which represents global institutional investors, said she "warmly welcomed" the move, which she said also would help lower overall transaction costs for investors.