HKEX Introduces Volatility Control Mechanism for its Securities Trading

HKEX’s VCM will look to shore up risk and volatility across its securities markets.

Hong Kong Exchanges and Clearing Limited (HKEX) is introducing its Volatility Control Mechanism (VCM), which acts as a measure designed to help protect market integrity through the prevention of fluctuations or extreme price volatility via trading errors.

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The VCM utility will look to shore up a number of potentially destabilizing incidents, including an array of potential episodic phenomena such as trading errors, glitches, or others. The function will be dedicated to HKEX’s securities market and will come into effect on August 22, 2016.

HKEX had originally proposed its VCM in a past consultation paper after the G20 and the International Organization of Securities Commissions collectively issued guidance on the release and presence of more control mechanisms across trading venues. Such efforts were designed to mitigate systemic risks arising from volatile market situations.

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As a result of consultation feedback however, HKEX ultimately decided to proceed forth with implementation of the VCM, though it has left the door open to future iterations, pending market participant feedback.

VCM Methodology

HKEX’s VCM is applied at an individual security level to Hang Seng Index (HSI) and Hang Seng China Enterprise Index (HSCEI, or H-shares Index), which boasts 81 securities at the present. More specifically, any attempt to trade a security covered by the VCM at a price more than 10% away from its last traded price five minutes prior will trigger a cooling-off period of five minutes where trading of the security can continue but within a band.

According to said Roger Lee, HKEX’s Head of Markets, in a recent statement on the VCM implementation: “The cooling-off period in the VCM mechanism alerts the market, provides a short time window allowing market participants to reassess their strategies and positions, and helps re-establish an orderly market at times when there is abrupt and drastic price movement for the security concerned.”

“The VCM is not intended to limit the ups and downs of stock prices due to fundamentals, and it should not be mistakenly seen as a trading halt mechanism or confused with the daily price limits that some markets use to keep a stock’s trading within a specific price range,” he reiterated.

“Our light-touch approach is also evidenced by back-test statistics for the past 10 years, which show triggers would have been very infrequent if we’d had a VCM. Given that the VCM is designed to safeguard the market from extreme price volatility arising from major trading incidents, market participants should not expect it to take effect very often and should continue to exercise due care and remain cautious in their trading.”

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