Regarding the Circular on the Amendment of the Settlement Price Calculation Method for Hang Seng Index Futures Options and Hang Seng China Enterprises Index Futures Options by the Hong Kong Futures Exchange Limited (MKS/EQD/02/22)
Release Date: 2022-05-04
Securities and Futures Commission
Email:
54th Floor, One Island East,
18 Westlands Road,
Quarry Bay, Hong Kong
May 4, 2022
To: Mr. Ashley Alder, Chief Executive Officer
Dear Mr. Alder,
Email:
54th Floor, One Island East,
18 Westlands Road,
Quarry Bay, Hong Kong
May 4, 2022
To: Mr. Ashley Alder, Chief Executive Officer
Dear Mr. Alder,
Regarding the Circular on the Amendment of the Settlement Price Calculation Method for Hang Seng Index Futures Options and Hang Seng China Enterprises Index Futures Options by the Hong Kong Futures Exchange Limited (MKS/EQD/02/22)
We express our opposition to the subject matter for the following reasons:
1. We do not concern ourselves with whether American or European options or the settlement method used, but the current settlement price is based on the Hang Seng Index spot price. Why would this not affect spot stock market participants? Why would it not impact the market?
2. At a meeting with representatives from the Hong Kong Futures Exchange Limited ("the Exchange") on May 3, 2022, it was noted that only 30 institutional investors were consulted, and the consultation was not public. Since spot stock market participants are stakeholders, why were they not consulted?
3. When the Hang Seng Index futures market was established in 1986, it was soon discovered that there were manipulations before the settlement day's close, leading to the introduction of the "Estimated Average Settlement" (EAS) by the Exchange, which was well-received by investors. However, the introduction of this new policy is regressive!
4. The Exchange's representatives used the February 2022 settlement day as an example, showing a significant discrepancy between the 4 PM closing price and the EAS, with substantial differences for some futures contract settlements. We pointed out that this was an extreme case. However, where there are losers, there are winners; this is a fair phenomenon. The example provided by the Exchange clearly favors one-sided stakeholders.
5. If the closing price is calculated using the last 5 minutes, it may facilitate market manipulation. Under the current system, calculating every 5 minutes throughout the trading day makes market manipulation difficult and is fairer.
6. Index futures options settle physically, but they ultimately return to the futures market, essentially allowing large or institutional investors to influence the futures market through the less liquid options market.
7. The logic of the calculation method is inconsistent:
The new method of calculation is essentially the same as the original method, both using an average calculation form. The Exchange's proposal that the new method can resolve the existing discrepancy between the futures options settlement price and the spot price, leading to direct losses in physical settlement of in-the-money values, essentially shows no significant difference.
8. Increase in human manipulation risk:
The Exchange also understands (or agrees with this view) that changing the settlement price from a full-day average to the new method's last 5-minute average lowers the uncertainty of the settlement price. However, we believe that reducing uncertainty actually increases the opportunity and risk of human manipulation, which is an undeniable fact.
9. Concentration of market participants:
The Exchange indicated that current data and information show that the vast majority of investors in this product (99%, according to the Exchange) are institutional investors. Compared to the entire market, the human manipulation risk for institutional investors is already higher, and the new measure further amplifies this risk. What is the purpose?
10. The new measure will significantly impact the volatility of the last 5 minutes:
10.1 The volatility will increase due to pricing every 5 seconds, potentially affecting other products (e.g., implied volatility, actual futures hedging activities, warrants indirectly affected by market volatility, other related derivatives).
10.2 Derivatives may be interconnected, such as warrants. If the last 5 minutes are exploited, it could trigger the withdrawal price of other derivatives.
10.3 Increased volatility may affect interoperability among institutional investors, dealers, and the Hong Kong Exchange during execution.
11. Potential future impacts
11.1 Image: Using short-term volatility as the pricing standard for the product's settlement price may not be positively perceived by the market, possibly leading to a negative image and a sense that "prices are manipulated." The impact on the financial market's image could outweigh the benefits. The potential overall impact must be carefully considered.
11.2 Concerns about other products using the same settlement method: Although the Exchange emphasizes that the new measure currently applies only to these products, the market will inevitably worry about other products being priced using the same method.
11.3 Future linkage with other products: A market primarily participated in by institutional investors suggests sufficient product creativity. If new products are linked to the current index futures options in the future, whether the risks are controllable is unknown.
11.4 If the Exchange's proposal is accepted by your Commission, international investors will undoubtedly question the fairness and justice of the Hong Kong financial market.
11.5 There are always winners and losers in the market, each bearing their own risks. Theoretically, the chances of winning and losing are equal. Since futures options have a dealer mechanism, the Exchange's proposal, combined with selective consultation with only 30 institutional investors, is clearly an unfair measure.
If you have any inquiries regarding this letter, please feel free to contact me at or Director of Industrial Relations Department Mr. Mofiz Chan.
Yours sincerely,
Wong Kwok On David
Chairman
Hong Kong Securities and Futures Professionals Association
(Act on behalf of Mofiz Chan)