Starting from Monday, 14 November 2016, the Hong Kong Exchanges and Clearing Limited (HKEX) will put into place its Volatility Control Mechanism (VCM) – a measure designed to cool the market for five minutes when there are abrupt price changes on some derivatives.
The fine-tuned features of HKEX’s “circuit breaker” will prevent price volatility arising from major trading errors and other unusual incidents such as a flash crash and algorithm errors.
The move will bring Hong Kong more closely in line with other major and regional markets that have implemented some form of VCM. But HKEX’s VCM is not expected to be triggered often, nor is it the sort of market-wide circuit breaker, since the mechanism stipulates a maximum of one trigger per instrument in the morning and afternoon trading sessions within a day.
Instead, if the price deviates more than a predefined percentage within a specific time frame, it will trigger a cooling-off period for five minutes to allow market participants to reassess their strategies.
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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.
How it works…
In the derivatives market, the HKEX’s VCM only applies to the spot month and next calendar month contracts of Hang Seng Index (HSI) Futures, Mini-HSI Futures, H-shares Index (HHI) Futures and Mini-HHI Futures.
The VCM will be triggered if a contract veers five percent – up and down – from a reference price that reflects the last traded price 5 minutes ago, excluding prices of a tailor-made combination trades and block trades (combo trades). After the trigger of VCM, a 5-minute cooling off period will start to allow trading within only the band. Normal trading will resume afterwards for the rest of the session without further intervention.
Finally, to allow free price discovery the cooling-off period excludes the Pre-Market Opening periods, After-Hours Futures Trading session, first 15 minutes of the morning and afternoon trading sessions and last 15 minutes of the afternoon trading session.
If there are no trades between the beginning of the trading session and the beginning of the VCM monitoring period, VCM monitoring will be postponed until after the first trade of the session.
Roger Lee, HKEX’s Head of Markets commented: “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 contract concerned.”
“The VCM is not intended to limit the ups and downs prices in normal market conditions. 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,” Mr Lee added.