Legco Special Meeting on January 28 2013, Proposal of the Hong Kong Exchanges and Clearing Limited to introduce after-hours futures trading CB(1)2330/11-12(01)

July 6, 2012

Chairman of the Legislative Council Panel on Financial Affairs

Hon. Mr. Chan Kam-lam,

Regarding the issue of follow-up on the after-hours futures trading session of the Hong Kong Stock Exchange by the Legislative Council Panel on Financial Affairs on July 10,

Our association has learned that the Legislative Council will discuss the aforementioned issue. We express our utmost gratitude and hope that justice can be upheld in the Legislative Council. We hereby present the following statements and requests for your reference regarding the aforementioned issue.

1. We have several questions about the content and conclusions of the consultation conducted by the Hong Kong Stock Exchange in May 2011, such as: Why did the Hong Kong Stock Exchange deliberately conceal the technical issues and default risks related to collecting margins after the close due to bank closures? Why was there no public consultation on the limits of price fluctuations? Why emphasize participatory nature when it is essentially a mandatory participation plan? This proves that the consultation was misleading to the public, and therefore, the conclusions are lacking in credibility and are incorrect. Regarding the consultation, our association has also sent letters to express the opinions of our members (see Attachment 1). Our association has about 2,800 members, but when aggregating responses, it was only counted as one unit, severely weakening the weight of our association's opinions, which is extremely unfair. Furthermore, the attitude of the Hong Kong Stock Exchange in handling consultation responses often manipulates public opinion and selectively takes what suits them, such as shortening lunch breaks, where the vast majority of the industry expressed strong opposition, but the Hong Kong Stock Exchange did not mention it. We strongly protest against this.

2. We have always believed that night futures trading is dangerous, non-transparent, unfair, and unnecessary; lacking transaction volume and credible data on spot trading levels for reference will only increase manipulation opportunities and harm investors' interests. We have also pointed out the default risks and forced liquidation waves triggered by similar cases, which could easily trigger financial crises, leading to a confidence crisis, panic selling of assets, and bank runs, resulting in financial disasters that are not worth the risks. (See detailed analysis in Attachment 2)

3. To truly reflect the industry's concerns, our association earnestly requests the Legislative Council to hold a public hearing and invite relevant industry representatives to express their opinions to the government.

4. Our association understands that the current Legislative Council will undergo elections as per regulations. Due to the serious public interest and safety issues involved, our association earnestly requests that the next Legislative Council continue to follow up on the issues involved.

Sincerely,

Wong Kwok-on David
Chairman
Hong Kong Securities and Futures Professionals Association



Attachment 1.

Opinions on the consultation paper regarding the establishment of after-hours futures trading sessions are unacceptable and firmly opposed. The primary task should be to improve the existing mechanism, require position limits, major shareholder disclosure reports, and a suspension mechanism.

After a detailed review and in-depth discussion by our members, the following conclusions and opinions are summarized:

1. The 2008 global financial market disaster was caused by excessive development of derivatives, lack of sufficient transparency, and limited regulation, culminating in the collapse of Lehman Brothers, a century-old institution, resulting in countless grievances and lawsuits, and evolving into political turmoil, pushing many large international financial institutions in Europe and America to the brink of bankruptcy, nearly causing a global financial system collapse. With global advanced countries tightening regulations and increasing transparency on derivatives and hedge funds to improve financial safety coefficients, we are puzzled and deeply regretful about the direction, purpose, principles, and spirit of the document, as well as the implementation of after-hours futures trading. It again proves that the exchange, under the guise of globalization, ignores financial transparency and safety, repeatedly reviving outdated systems, favoring market makers, and harming the interests of small investors, ultimately undermining the entire financial safety and stability. Our association will firmly oppose and defend our stance.

2. Futures trading can bring positive hedging power to the market, but the arrangements must be comprehensive and diverse. Solely developing futures trading without the support of other spot (long and short) and options trading makes it easily a tool for market manipulation. In unexpected negative events, it can become a strong destructive weapon, directly impacting the stock market and the entire financial system. During the 1987 stock market crash, Hong Kong's excessive single-sided development of futures without the support of shorting stocks and options led to a futures market collapse after four days of market closure, directly dragging down the stock market. If not for special arrangements for major players to take over the liquidation, the consequences would have been unimaginable. The current arrangement of launching naked single-sided futures trading after the spot market closes is reminiscent of the situation before the 1987 stock market crash, as other trades cannot be hedged after the market closes.

3. Although the Hong Kong and global stock markets have developed over the years, providing a variety of hedging tools, due to the lack of transparency in derivative tools and hedge fund operations, coupled with technological advancements and the automation of computer program trading, uncontrolled fluctuations often occur even during normal spot trading hours. The 2008 financial crisis is a classic example, bringing painful lessons. Despite extensive research and improvements post-crisis, uncontrolled phenomena still occur, as evidenced by the May 6, 2010, Dow Jones flash crash. After-the-fact investigations and improvements are common, but the damage is already done. Thus, implementing after-hours futures trading is extremely dangerous, bound to result in uncontrolled fluctuations, further threatening the entire stock market and economy.

4. Most of our opposition to new trading policies is not due to opposition to the development of Hong Kong's stock market scale and internationalization. Our position is that expanding the existing scale or time frame must involve correcting flaws and improving the system. We believe the primary task is to improve the existing trading mechanism to reduce potential uncontrolled crises, focusing on safety and transparency. Only when we have confidence in the improved trading mechanism will we consider extending trading hours.

5. Regardless of whether the exchange accepts our opposition to implementing after-hours futures trading, we must insist on increasing market suspension arrangements and imposing position disclosure and limit restrictions as our bottom line. These measures not only affect stock market stability but also threaten the entire financial and economic safety.

6. Currently, individual stock transactions require related parties' trading and position levels disclosure, and the Securities and Futures Ordinance requires major shareholders (over 5%) to disclose similarly. The principle is to maintain market fairness and transparency. Our association believes the same principle should apply to futures trading participants. If an individual independent investment unit's futures positions exceed 5% of the total open interest, their short positions and subsequent trades must be publicly disclosed until reduced below 5%, aligning with modern principles of increasing market transparency and informed rights.

7. Reasonable futures trading can provide bilateral movement opportunities for the market in different time frames, avoiding extreme unilateral rises or falls and offering buffering power for fluctuations. However, if individual investment entities excessively speculate and establish large short positions, it will not only endanger the financial stability of the relevant entities but also lead to excessive gambling and speculative behavior in the market, causing irrational market volatility. Regardless of the outcome, the entire market and investors ultimately suffer damage and destruction, as evidenced by Lehman Brothers and AIG in 2008. Learning from past lessons, our association believes there should be a cap on individual investment units' short positions as a percentage of total short positions, such as 10%, to reduce leverage risk and market-making motives.

8. As previously discussed, futures activities can bring positive buffering power to the market, but objective conditions require maintaining a fair and just environment. If the market experiences unusual factors, allowing short selling activities may lead to disastrous consequences, severely damaging investors' confidence in investment value and impacting the entire economic system. In recent years, hedge funds have become more sophisticated and professional in organizing market-making, collaborating with large securities firms, publishing research reports and financial ratings aligned with their direction, selectively disseminating information, and even resorting to rumors to achieve profit goals. Therefore, extraordinary measures are required in extraordinary times. Our association strongly recommends that when the market becomes uncontrollable, futures activities should be suspended. We suggest defining a market environment as extraordinary if the Hang Seng Index falls by 5% in a single day, at which point futures activities should be prohibited.


Attachment 2

Concerns about financial safety, firmly demanding a trial period for after-hours futures trading, and strongly requesting a fluctuation limit of no more than 2.5% during the trial period, followed by a comprehensive consultation.

Our association fundamentally opposes the hasty implementation of after-hours futures trading, believing it carries significant risk and potential financial disaster, including systemic risks and bank runs, ultimately leaving all Hong Kong citizens to bear the cost. Even if the Hong Kong Stock Exchange considers this an inevitable development towards internationalization, our association insists that a cautious attitude be adopted during the trial of the new system, learning from experience, with a fluctuation limit of 2.5% per session, followed by a comprehensive consultation review.

Stocks are indicators of confidence

In the current globally integrated economy, individual regions cannot remain isolated. Similarly, individual investment markets cannot be separated from the entire economic system. Stock prices within acceptable ranges represent evaluations and trade-offs of investment value. Once rapid fluctuations exceed warning thresholds, it can evolve into a confidence crisis. Rapid rises can create bubbles, laying a potential crisis for steep declines. Rapid collapses, coupled with news, reports, and rumors, further trigger confidence crises, leading to irrational asset sell-offs and bank runs, impacting the entire society. In November 1997, there was a bank run on Hong Kong Bank; just a month earlier, the Hang Seng Index had plummeted from a high of 15,133 to a low of 8,776, a drop of 6,357 points. On September 24, 2008, there was a bank run on East Asia Bank; that year, the Hang Seng Index fell 7,822 points from a high of 26,322 in May to a low of 18,500 in September, with similar circumstances.

Hong Kong's global trading options need gradual development, with significant improvements in acceptance, popularity, and maturity

1. Although Hong Kong's stock market ranks among the world's seven largest by market capitalization, it is considered an emerging market. Neither in scale, history, maturity, nor acceptance can it compare with Europe and America. The resulting trading volume and index level acceptance are therefore questionable.

2. During the launch period, only futures trading is provided without concurrent spot and other hedging products, lacking credible reference data, making it susceptible to manipulation and ultimately impacting the next day's trading market.

3. After-hours futures trading primarily occurs during Hong Kong people's rest periods, with expected sparse trading and questionable transparency, warranting cautious experimentation.

4. The original design's 5% fluctuation limit contains significant hidden risk traps. In a market crash, under a major decline, uncontrolled forced liquidations may occur, creating widespread default risks that could threaten brokers' solvency, leading to financial disasters. Here is an example:

Current initial margin: 67,000 (deducting 50 points per point, approximately 1,340 points buffer)
Maintenance margin: 51,000 (deducting 50 points per point, approximately 1,020 points buffer)
Current Hang Seng Index level: 21,640
Fluctuation limit: Up/Down 1,082 points

Example,

i. A client opens a position with full margin payment. At the official close, a 320-point drop touches the maintenance margin, requiring no margin call,
ii. If during the after-hours session, the market quickly (whether artificially or not) falls to the fluctuation limit of 1,082 points, the client's account is effectively negative. Due to the rapid uncontrolled fall, computer stop-loss liquidations are likely to fail. At night, with banks closed, trust between clients and brokers may be lost.
iii. In extreme cases, the next day's opening might result in a gap down, further enlarging the client's negative balance, threatening brokers' solvency. Unable to wait for client deposits, brokers may forcibly liquidate positions at any price, allowing hedge funds and manipulators to apply downward pressure, profiting and leaving brokers and clients to dispute and handle a pile of bad debts, potentially causing some brokers to collapse, triggering a domino effect and social conflict. This is a highly dangerous trap, as evidenced by the Lehman Brothers' financial disaster, which should not be overlooked.

The above example is neither extreme nor far-fetched. Between August and October 2011 alone:
                    

All drops exceeded 1,200 points, without considering the drop before and after the day, enough to erode most initial margins. Seven days occurred in the past four years, not considered sporadic events.

According to our data, among the more actively traded futures, most are U.S. Dow Futures and S&P Futures indices, Nikkei Index, or individual European financial market indices. Others, such as MSCI Taiwan Index and MSCI Singapore Index, offer after-hours trading, but the products involved are self-made by investment banks, with no official index providing these services. It is evident that after-hours trading for official indices in emerging markets is extremely rare, reflecting limited demand, and both its acceptance and credibility, transparency, and fairness are seriously questionable!

The plan is experimental, without precedence, involving the serious issue of Hong Kong's overall financial safety. The original design is entirely inadequate to cope with past and future financial disasters, lacking emergency remedial measures to address risk compensation crises. We firmly demand a trial period for after-hours futures trading, strongly requesting a fluctuation limit of no more than 2.5% during the trial period, followed by a comprehensive consultation review.

Wong Kwok-on David
Chairman
Hong Kong Securities and Futures Professionals Association
 

Speech by Chairman Mr. Wong Kwok On David

Speech by Mr. Mofiz Chan