1、August 2022Observations on Market Liquidity EnhancementFSDC Paper No.54ContentsExecutive SummaryBackground Market liquidity and its importance Global market liquidity ETFs and Market Makers ETF liquidity and spill-over effects ETF liquidity and market depthMarket makers and the trading ecosystemCase

2、 Studies:Infrastructure Enhancements and Their Impact on LiquidityExample 1:HKEX-Improved liquidity from stamp-duty exemptions for ETFs Example 2:Tokyo Stock Exchange-Improved liquidity from streamlined ETF settlement processExample 3:Enhanced trading environment via self-match prevention mechanisms

3、Cost benefit analysis of infrastructure enhancements Potential Measures to Enhance Market Liquidity Enhancements of ETF trading activities Enhancements of general trading and clearing activities Upgrade of infrastructure and systems Conclusion Appendices Appendix 1.Market makers sources of profitApp

4、endix 2.Markets that have implemented self-match prevention mechanisms on multiple exchanges since 2008(by region)1223771213151517 18192020232527282829Executive SummaryHong Kong has been a successful world-leading IPO centre,having ranked first in IPO funds raised globally in seven out of the past 1

5、3 years.1 Such a status has been,in part,supported by Hong Kongs proximity and connectivity to the Mainland market,benefiting from the continuous economic growth and innovation of the latter.Despite the strong IPO market performance,secondary market activities in Hong Kong are arguably less vibrant,

6、especially comparing to other leading global financial centres.Secondary market liquidity is an important indicator showing the level of development and sophistication of a market.Numerous studies have shown that stocks with higher liquidity tend to trade at a premium and,thus,at higher prices.Tradi

7、ng liquidity is not only important for secondary market investors,but also crucial to increasing a markets appeal to potential issuers,for whom the companys valuation is a key determining factor affecting the choice of a listing and trading venue.With heightened uncertainties revolving around the gl

8、obal financial arena,as well as potential opportunities arising therein,Hong Kong should strive to continuously enhance its trading mechanism and market infrastructure to cater to the changing needs of issuers and investors.With the above in mind,the FSDC initiated a study and prepared this paper wi

9、th an aim of identifying potential mechanism enhancements that can boost market liquidity in Hong Kong.Recommendations set forth in this paper have a focus on facilitating activities of exchange traded funds(ETFs)and market makers who can,in turn,better discharge their market function as liquidity p

10、roviders to create a virtuous circle benefitting the market as a whole.The recommendations are summarised as follows:It is believed that the proposed enhancements will foster market liquidity,and,thereby,cement Hong Kongs status as a first-class international financial centre.HKSAR Government,“Natio

11、nal plan hugely benefits HK”(26 May 2022),https:/www.news.gov.hk/eng/2022/05/20220526/20220526_182018_303.html(accessed on 29 May 2022)1Introducing a new spread table with tick sizes more suitable for Hong Kong-listed stocks;Increasing the maximum spread range requirement to above 24 spreads;Extendi

12、ng the market maker short sell permission for manual trades;andIntroducing adjustments to ETF settlement approaches.1.2.3.4.Enhancements of ETF trading activities:Introducing new rules that allow market makers to have multiple clearing participants;Assessing portfolio risks of market participants ac

13、ross the central counterparties;and Considering market maker programmes for illiquid stocks to improve liquidity.1.2.3.Enhancements of general trading and clearing activities:Adopting an opt-in self-match prevention mechanism by the Hong Kong Exchanges and Clearing Limited(HKEX);Providing more trans

14、parency on picked gateways connecting members and exchanges;andUpgrading trading system with advanced technology accompanied with capacity building.1.2.3.Upgrade of infrastructure and systems:1BackgroundMarket liquidity can be broadly defined as a markets ability to facilitate a large volume of tran

15、sac-tions rapidly with little impact on price.2 The concept of liquid has multiple dimensions,namely:3 Higher liquidity of a market makes it more appealing to different stakeholders of the financial market.For investors,a more liquid market would generally translate into lower trading cost,higher tr

16、ansaction efficiency,lower price volatility,and improved price formation.For issuers,a more liquid market would offer lower cost for raising capital and more accurate share price valuations.As for stock exchanges,higher liquidity increases the attractiveness of the market to investors,issuers and ot

17、her market participants,and therefore brings about greater transaction volumes and profitability of the exchange.As liquidity serves to deepen and strengthen a financial market and has a positive impact on overall financial market stability and development,it is a common objective among global regul

18、ators,stock exchanges and other stakeholders to ensure their markets exhibit a vibrant and healthy level of liquidity.Market liquidity and its importanceBreadth/tightness refers to the difference between buy and sell prices.Breadth is usually identified and measured by the bid-ask spread.Tighter spr

19、eads encourage more active trading,and hence leads to better liquidity.Depth refers to the number of pending orders on both sides of the bid-ask spread.The larger the number,the better,as this limits the influence of orders on price.Immediacy refers to the speed at which orders can be executed at a

20、given cost.Resilience refers to the speed at which prices return to stability after a temporary shock.Bank for International Settlements(BIS),“BIS quarterly review”(November 2000),https:/www.bis.org/publ/r_qt0011e.pdf Oliver Wyman and World Federation of Exchanges,“Enhancing Liquidity in Emerging Ma

21、rket Exchanges”(October 2016),https:/ 232As mentioned above,enhancing market liquidity is an objective of stock exchanges,and there is no exception for HKEX.Despite collective efforts of HKEX and the financial market as a whole,the liquidity of Hong Kongs financial market still presents room for imp

22、rovement.Although the average daily turnover of HKEX(figure 1)has generally shown an upward trend over the past years,4 turnover velocity(value traded relative to the overall capitalisation),an indicator that reflects liquidity of a market,continues to be lagging other major exchanges globally.More

23、specifically,the turnover velocity of HKEX was at 76.4%in 2021,while that of other major exchanges tends to be well above 100%(figure 2).5 Global market liquidity Figure 1.Figure 2.Source:HKEX Source:World Federation of Exchanges 180,000160,000140,000120,000100,00080,00060,00040,00020,00002018201920

24、1720162015201420132012HKD(mn)2022Jan-Jul2021202087,155107,41088,24966,924105,63069,45662,56053,850134,019166，730129，476Hong Kong Securities Market Average Daily Turnover300%250%200%150%109.0%273.7%100.4%260.9%76.4%36.7%100%50%0%US(Nasdaq+NYSE)Mainland China(SSE+SZSE)JapanExchangeGroupKoreaExchange20

25、2020212019HKEXSingaporeExchangeValue of Equity Share Trading/Market CapitalisationHKEX,Annual Market Statistics,https:/.hk/Market-Data/Statistics/Consolidated-Reports/Annual-Market-Statistics?sc_lang=en;HKEX,HKEX Monthly Market Highlights,https:/.hk/Market-Data/Statistics/Consolidated-Reports/HKEX-M

26、onthly-Market-Highlights?sc_lang=en(all accessed on 24 June 2022)World Federation of Exchanges,Annual Statistics Guides,https:/www.world-exchanges.org/our-work/research/archive/statistics-focus(accessed on 24 June 2022)453Exchange Participants principal trading turnover accounts for only 28.1%of tot

27、al market share in 2020.Turnover from market makers/high frequency trading,quantitative funds and hedge funds accounts for 67.9%of total market share in 2020,and 65.9%in 2021.Drawing references to the US market one of the most liquid markets in the world it is shown that market makers and ETFs,among

28、 others,have accounted for much liquidity of the US market.Market makers:Comparing the investor types of the US and Hong Kong markets,market turnover in the US is predominately contributed by market makers/high frequency traders,quantitative funds and hedge funds,who took up a total of 67.9%in 2020

29、and 65.9%in 2021.6 These market participants(roughly categorised as Exchanges Participants)7 only accounted for 28.1%of the market turnover in Hong Kong in 2020.8 Figure 3.Figure 4.Source:HKEXSource:Bloomberg Intelligence2020 US MarketTurnover by Investor Types43.5%15.5%8.9%20%6.3%5.8%Quantitative F

30、undsHedge FundsIndividual InvestorsLong-only FundBanksMarket Makers/High Frequency Trading2021 US MarketTurnover by Investor Types42.4%13.7%9.8%20.6%7.3%6.3%2020 HKEX Cash MarketTurnover by Investor Types56.4%28.1%15.5%Exchange ParticipantsIndividual InvestorsInstitutional InvestorsBloomberg Intelli

31、gence(accessed on 5 August 2022)An exchange participant is a corporation who may trade on or through the Exchange and is licensed under the Securities and Futures Ordinance to carry on securities/futures/options dealing activity.Please refer to HKEX,Exchange Participant Data,https:/.hk/Market-Data/S

32、tatistics/Partici-pant/Exchange-Participant-Data?sc_lang=en(accessed on 31 May 2022)HKEX,“Cash Market Transaction Survey 2020”(April 2022),https:/.hk/-/media/HKEX-Market/News/Research-Reports/HKEX-Surveys/Cash-Market-Transaction-Survey-2020/CMTS2020_e.pdf 6784Zooming into the role of market makers i

33、n different major stock exchanges.In the New York Stock Exchange(NYSE),there are more than 140 liquidity providers for NYSE-listed securities as of July 2022.9 In addition,according to the US Securities and Exchange Commission,there are more than 260 market-making firms providing liquidity for Nasda

34、q-listed stocks.10 In contrast,there are merely over 30 market makers(known as Securities Market Makers and Designated Specialists collectively)providing market liquidity to Exchange Traded Products(ETPs)on HKEX as of June 2022.11 ETFs:In general,ETFs are considered an attractive investment vehicle

35、among investors due in part to its high liquidity characteristics.12 In 2021,ETFs accounted for about 25%of the total US stock trading by volume,playing an essential role in facilitating the overall liquidity of the market,directly and indirectly.13 As of 27 May 2022,the average daily value of US ET

36、F transactions stood at US$237.98 billion.14 Figure 5.Source:Bloomberg,Cboe Exchange,Inc.,Investment Company Institute45%50%40%35%30%25%20%15%10%5%0%2019201820172016201520142013201220112021202036%43%35%36%38%38%40%37%38%36%40%27%27%25%27%26%25%26%26%30%25%26%18%16%16%20%17%14%18%17%20%14%15%ETF Seco

37、ndary Market Trading Averaged 25 Percent of Daily US Stock Trading in 2021Maximum Daily ETF Share for the YearAverage Daily ETF Share of Total US Stock Market TradingMinimum Daily ETF Share for the YearNYSE,Membership,https:/ on 14 July 2022)US Securities and Exchange Commission,Nasdaq Market Center

38、 Systems Description,https:/www.sec.gov/rules/other/nasdaqllcf1a4_5/e_sysdesc.pdf(accessed on 26 June 2022)HKEX,Exchange Traded Product List of Securities Market Makers,https:/.hk/Products/Securities/Exchange-Traded-Products/Market-Makers/List-of-Market-Makers?sc_lang=en#:text=There%20are%20over%203

39、0%20Securities,Products%20(ETPs)%20on%20HKEX.(accessed on 26 June 2022)JP Morgan,“ETF Liquidity:Trading during volatile markets”,https:/ on 29 June 2022)The Investment Company Institute,“2022 Investment Company Fact Book”(2022),https:/www.icifactbook.org/pdf/2022_factbook.pdf New York Stock Exchange

40、(NYSE),NYSE Arca ETF Quarterly Report,https:/ on 27 May 2022)910111213145Figure 6.Figure 7.Source:HKEX Source:Morningstar,Wind Information,China International Capital Corporation(CICC)Looking into the scale of ETF assets under management(AUM)by markets,Hong Kongs ETF market also exhibits significant

41、 room for improvement.As of 1Q2022,Hong Kongs ETF market scale was modest(US$37 billion)in comparison to US$7.1 trillion in the US,19 whose size was more than seven times larger than any other major global markets.In this regard,with its advantages to investors and the importance to the market struc

42、ture,Hong Kong should consider facilitating the further development of the ETF ecosystem.9%10%8%7%6%5%4%3%2%1%0%10987654321020192018201720162015201420132012202120203.9%5.9%6.8%8.3%6.2%4.9%3.7%5.0%3.8%4.0%ETFs as a Percentage of Overall Hong Kong Trading(2012-2021)2.13.74.78.84.14.34.04.44.96.6ETFs(H

43、KD bn)%of Total Market Turnover7,0891,036510322218378,0006,0004,0002,0000Mainland ChinaLuxembourgJapanIrelandUSUSD(bn)Hong KongETF AUM by Markets in 1Q2022HKEX,Key Market Data,https:/ on 31 May 2022)HKEX,HKEX Monthly Market Highlights,https:/.hk/Market-Data/Statistics/Consolidated-Reports/HKEX-Month

44、ly-Market-Highlights?sc_ lang=en&select=40F215EC-D057-4C61-9293-114240C470CD(accessed on 27 May 2022)Investment Company Institute,“2022 Investment Company Fact Book”(2022),https:/www.icifactbook.org/pdf/2022_factbook.pdf(accessed on 28 June 2022)HKEX,“HKEX to Include ETFs in Stock Connect on 4 July”

45、(28 June 2022),https:/.hk/News/News-Release/2022/220628news?sc_lang=en(accessed on 28 June 2022)CICC,“全球ETF市場發展分析：被忽視的ETF“試驗場”加拿大篇”(17 May 2022)https:/ on 23 June 2022)1516171819In contrast,Hong Kongs ETFs average daily turnover represented less than 10%of total market trading volume over the last 1

46、0 years.15 While a significant growth in turnover is observed in Hong Kongs ETF market in 2015,it was not sustained afterwards,with the average daily turnover staying at roughly 4%of the market total in 2021.16 Compared to the US(25%),there remains huge potential for growth in ETFs representation in

47、 Hong Kongs market.17 We are,therefore,encouraged to see the inclusion of ETFs in the Stock Connect programme(known as“ETF Connect”)commencing on 4 July 2022.18 It is believed that the new inclusion will create additional business opportunities,thereby will help fostering the healthy development of

48、the ETF market,therefore further enhancing the liquidity of the secondary market.6With the intertwined relationships,the trading of ETFs may bring about liquidity on general securities,futures and options;that is,the spill-over effect of liquidity leading to changes from one market to another.21 Suc

49、h spill-over effects result in direct demand shocks,leading to volatility of its underlying securities and key constituents,resulting in changes in liquidity situations,vice versa.ETFs and Market Makers As shown above,from the experience of the US market,ETFs and market makers are two important grou

50、ps of market participants and major contributors to market liquidity.Given their respective roles as passive investment managers and liquidity providers,their ability to better discharge such market functions will play a significant part in facilitating transactions and thus enhancing liquidity in a

51、 market.This section dives deeper into the development trends and market functions of market makers and ETFs.ETF liquidity spill-over effectsETFs,according to the definition of HKEX,“”are hybrid securities,combining features of both mutual funds and stocks.Like mutual funds,ETFs are open-end funds c

52、onsisting of a portfolio of securities that is assembled according to an investment objective and strategy.Like listed shares of companies,ETF shares can be traded on an exchange,at any time of day while the markets are open,whereas mutual funds or unit trust investments often have restrictions on t

53、he frequency with which buy or sell orders are processed typically once per day.20Impact on general securitiesAdvantages of investing through ETFs,such as low-cost trading and easy access to a variety of asset classes,have encouraged investors to broaden the uses of ETFs.ETFs can be used for strateg

54、ic trading such as asset allocation,liquidity management,and portfolio completion and tactical uses such astactical adjustments,cash equitization,and leveraged and inverse investing.Therefore,as the tradingactivities of ETFs increase,the liquidity of those general securities will also be enhanced.Fi

55、gure 8.ETF Liquidity Spillover on General SecuritesHKEX,“ETF Handbook”,https:/.hk/-/media/HKEX-Market/Products/Securities/Exchange-Traded-Products/Launch/HKEX_ETF-Handbook.pdf(accessed on 5 May 2022)Pham,Son D.,Ben R.Marshall,Nhut H.Nguyen,and Nuttawat Visaltanachoti,Liquidity Spillover between ETFs

56、 and Their Constituents(2021),https:/pa- on 5 May 2022)20217Impact on underlying securitiesThe trading of ETF affects liquidity across other asset classes,including individual stocks,futures,options and derivatives.For example,in the US,substantial portions of individual stocks are held by ETFs(figu

57、re 9.).The underlying securities will be traded when creation/redemption or rebalancing events happen.As the AUM and trading activities of ETFs continue to grow,the liquidity and price discovery of underlying securities will improve as well.Figure 9.Source:BloombergNameSectorMarket Cap(mn of USD)%of

58、 Weight held by all ETFsAmerican States Water Co.Universal Corp/VASouth Jersey IndustriesCalifornia Water Service GroupHelix Energy Solutions GroupCoeur Mining IncBadger Meter IncNew Jersey Resources CorporationArmour Residential Reit IncBrady Corporation Class AAvista CorporationLTC Properties,Inc.

59、Petmed Express IncAerovironment IncAbm Industries IncItron IncIndustrial Logistics Properties Trust Global Net Lease Inc Carpenter Technology CorporationBlack Hills CorpUtilities Food,beverage&tobacco Utilities UtilitiesEnergyMaterials Technology hardware&equipment Utilities Diversified financials C

60、ommercial&Professional Services Utilities Real estate RetailingCapital goods Commercial&professional services Technology hardware&equipment Real estate Real estate Materials Utilities 3,0931,4964,1813,0654768622,3594,3747462,3703,2451,5321,4172,1432,8852,1789301,4901,3234,90133.931.931.631.130.029.9

61、29.329.328.928.928.028.027.827.527.227.227.126.626.526.2Ownership%of Selected Individual Stocks Market Cap Held by ETFs in the US(as of March 2022)Source:Bloomberg8Impact on the futures marketHistorically,ETFs have also demonstrated positive liquidity spill-over effects on the futures market.Take th

62、e commonly traded FTSE China A50 Futures launched in 2006 as an example.Trading activities were rather limited in early-2000s when it was first introduced to the market,but the situation improved notably when the trading activities of iShares FTSE China A50 ETF(2823.HK)increased22 and after the laun

63、ch of CSOP FTSE China A50 ETF(2822.HK)in 2012.As shown in figure 10,the trading volume of the two FTSE China A50 ETFs has demonstrated a positive relationship with the growth in the trading of the underlying futures.ETF liquidity spill-over on optionsWhen market volatility increases,the turnover of

64、ETFs and related options tend to increase at the same time,as they are considered important tactical trading tools.As shown in figure 11,when the implied volatility of FXI(China Large-cap ETF)and KWEB(China Internet ETF)went up,the turnover of ETFs and open interest of options(figure 12)also spiked,

65、indicating a higher level of hedging activities.Figure 10.Source:Bloomberg10090807060504030201001009080706050403020100201820172016201520142013201220112010200920082007200620052004FTSE China A50 Futures Volume(mn)FTSE A50 ETF(2822+2823)Volume(bn)FTSE China A50 Futures Volume(mn)202120202019FTSE China

66、A50 Futures and ETFs Trading VolumeFTSE A50 ETF(2822+2823)Volume(bn)2823.HK listed(launched in 2004)FTSE China A50 Futures(launched in 2006)2822.HK listed(launched in 2012)iShares FTSE China A50 ETF was launched in 2004.229Source:BloombergFigure 11.6,0005,0004,0003,0002,0001,00006050403020100May2022

67、Apr2022Mar2022Feb2022Jan2022Dec2021Nov2021Oct2021Sep2021Aug2021Jul2021Jun2021May2021Apr2021Mar2021Feb2021Jan2021Dec2020Jun2022Implied VolatilityTurnover(USD mn)Notable pointsFXI Implied Volatility and Turnover2,000,0001,600,0001,800,0001,200,0001,400,0001,000,000800,000600,000400,000200,000060405020

68、30100May2022Apr2022Mar2022Feb2022Jan2022Dec2021Nov2021Oct2021Sep2021Aug2021Jul2021Jun2021May2021Apr2021Mar2021Feb2021Jan2021Dec2020Jun2022Implied VolatilityOpen Interest Total PutNotable pointsFXI Implied Volatility and Open Interest Total Put10Figure 12.3,5003,0002,5002,0001,5001,000500012010080604

69、0200May2022Apr2022Mar2022Feb2022Jan2022Dec2021Nov2021Oct2021Sep2021Aug2021Jul2021Jun2021May2021Apr2021Mar2021Feb2021Jan2021Dec2020Jun2022Implied VolatilityTurnover(USD mn)Notable pointsKWEB Implied Volatility and TurnoverSource:Bloomberg600,000700,000500,000400,000300,000200,000100,00001208010040602

70、00May2022Apr2022Mar2022Feb2022Jan2022Dec2021Nov2021Oct2021Sep2021Aug2021Jul2021Jun2021May2021Apr2021Mar2021Feb2021Jan2021Dec2020Jun2022Implied VolatilityOpen Interest Total PutNotable pointsKWEB Implied Volatility and Open Interest Total Put11Source:HKEXTrading of ETFs improves market depth and liqu

71、idity.Generally,an ETF is categorised as an open-end fund as it consists of multiple underlying assets,with no limits on the number of shares that can be created and redeemed.Given this nature,unlike individual stocks,drawing implications from the average daily volume of an ETF alone might not be ab

72、le to reveal the complete picture of its liquidity.In this regard,it is worth noting that when the liquidity of ETFs is discussed,multiple dimensions need to be taken into consideration23,24:With the above in mind,an ETF can be more liquid than it appears on-screen,which explains why the average dai

73、ly volume on exchange platforms may neither necessarily equal to nor be indicative of an ETFs actual liquidity.As an extreme but not uncommon example,an ETF with low trading volume can be considered liquid if its underlying holdings are liquid.As mentioned,the underlying liquidity has a positive rel

74、ationship with the liquidity of the underlying holdings/securities.Therefore,as long as the underlying holdings are liquid for instance,they provide tight bid-ask spreads,and that the orders on both buy and sell sides are significant enough the liquidity profile of that ETF may mirror liquidity of t

75、he underlying securities/holdings.26 ETF liquidity and market depthOn-screen liquidity the most visible source of liquidity that refers to typical trading orders in the secondary market conducted by typical investors.This can be assessed by looking into the average trading volume and the bid-ask spr

76、ead of the ETF.The information available“on-screen”,however,only reflects a fraction of the ETFs liquidity.Hidden liquidity refers to off-exchange transactions,which are generally,other than the highest bid and lowest ask that are publicly available,additional quotes that can be accessed with the as

77、sistance of brokers/market makers.Hidden liquidity is a reflection of“market makers inventory that has not been committed to the market and inventory that is available through over-the-counter(OTC)platforms and securities borrowing”.25 Underlying liquidity among market participants,this is considere

78、d as the fundamental and deepest source of an ETFs liquidity,which can be accessed through the process of creation and redemption of shares in the primary market.The underlying liquidity is derived from its underlying holdings/securities and,thus,there is an established positive relationship between

79、 such.1)2)3)Figure 13.On-exchangeOff-exchangeOn-Screen Liquidity:A reflection of the average trading volume as well as the bid-ask spreadon exchangeHidden Liquidity:Market Makers liquidity and position reflected by OTC volumesUnderlying Liquidity:Derived from the underlying holdings/securitiesDeepen

80、 the Market through Multiple Layers for Trading LiquidityHKEX,“ETF Handbook”,https:/.hk/-/media/HKEX-Market/Products/Securities/Exchange-Traded-Products/Launch/HKEX_ETF-Handbook.pdf(accessed on 5 May 2022)American Century Investments,“ETFs:Three Levels of Liquidity for Greater Access to the Market”(

81、24 March 2021),https:/ on 29 June 2022)HKEX,“Assessing the Impact of HKEXs ETF Liquidity Enhancements”(December 2022),https:/.hk/-/media/HKEX-Market/Products/Secu-rities/Exchange-Traded-Products/Attachment/HKEX-Assessing-the-impact-of-HKEX_s-ETF-liquidity-enhancements_whitepaper_en.pdf(accessed on 2

82、3 June 2022)Central Bank of Ireland,“Response to the Central Bank of Irelands Discussion Paper on Exchange Traded Funds(“ETFs”)”(11 August 2017),https:/ww-w.centralbank.ie/docs/default-source/publications/discussion-papers/discussion-paper-6/vanguard-group-response-etf-discussion-paper.pdf?sfvrsn=0(

83、accessed on 27 June 2022)2324252612Market makers and the trading ecosystemThe primary role of a“market maker”is to create liquidity by being ready to buy and sell securities within the market at publicly quoted prices,27 and therefore they are indispensable to a highly liquid market.According to HKE

84、X,market makers“contribute to Hong Kongs market quality by providing improved liquidity and price efficiency,enabling investors to trade in a timely manner and at a lower transaction cost”.28 They are recognised as a key source of liquidity for various financial products,such as ETFs,stocks,options

85、and futures.Using ETFs as an example,based on our exchanges with ETF operators and managers,market makers actively offer bid-ask quotes to market participants and are,thus,instrumental in enhancing the efficiency of the market.In certain markets such as the US,maker makers contributed around 16%of t

86、he liquidity created in the US market.29 Market makers are commonly present in most developed markets,and they have seen increasing popularity in other emerging market exchanges.30 Under these schemes,market makers usually need to fulfil certain obligations set out by their respective exchanges and

87、are,in return,compensated via certain incentives such as fee rebates.The obligations of market makers,as set out by the stock exchanges,usually involve trading actively in a wide range of securities,which would lead to:Narrower bid-ask spreads,and hence accelerating fair price discovery;Higher quote

88、d quantities,thus enhancing robustness of market liquidity;andHigher liquidity in the market,both on-screen and off-screen.Functions of market makers throughout the product lifecycle:Figure 14 below shows how market makers function as liquidity providers for a product throughout the product lifecycl

89、e.As there is a cluster of market participants involved at different stages in the full cycle of a new product,from initiation to maturity,market makers play a crucial role in connecting different participants,and they are involved at each and every step throughout the process to facilitate the laun

90、ch and implementation of the product.NYSE,“Market Makers in Financial Markets:Their Role,How They Function,Why They are Important,and theNYSE DMM Difference”(September 2021),https:/ on 26 June 2022)HKEX,Exchange Traded Product Overview https:/.hk/Products/Securities/Exchange-Traded-Products/Market-M

91、akers/Overview?sc_lang=en(accessed on 24 May 2022)Nasdaq,“Who is Trading on U.S.Markets?”(28 January 2021),https:/ on 20 July 2020)Oliver Wyman and World Federation of Exchanges,“Enhancing Liquidity in Emerging Market Exchanges”(October 2016),https:/ on 5 May 2022)2728293013Developing stage prior to

92、 the launch,substantial support is required,especially from market makers.Market makers provide initial liquidity to a product from day one,when investors are still observing market makers pricing of a new product before investing.Early adopters market makers actively facilitate market demand from e

93、arly adopters such as retail and professional investors with sizable amounts through the creation and redemption of shares.31 Their sizes increase as more investors are involved,which may help provide tighter bid-ask spreads.Acceleration stage market makers formulate trading strategies and favourabl

94、e offerings to encourage more players to participate in the market.“Speculators”are more likely to enter the market after seeing sufficient product turnover,and thereby further contribute to boosting liquidity.Mature stage as the market becomes more efficient and vibrant through facilitation adjustm

95、ents,attracting more long-term“real-money”investors who can fund investments at their full value.More types of trading are expected to happen at this stage,including arbitrage between derivatives/ETFs,quantitative trading strategies,long/short strategies,etc.1.2.3.4.As demonstrated above,market make

96、rs serve as the connector among stakeholders in the product lifecycle.They cater to demands from various dimensions through(i)providing liquidity while improving market depth,(ii)facilitating tighter bid-ask spread to lower trading costs,and(iii)allowing direct trades to reduce market impact.Conside

97、ring the above,the FSDC believes that the some 30 Securities Market Makers and Designated Specialists with presence in Hong Kong,including the global leading ones,fuel the development of Hong Kongs capital market by improving liquidity and pricing efficiency.Figure 14.1.Developing Stage3.Acceleratio

98、n StageE.g.MSCI A504.Mature Stage2.Early AdoptersHKEX,“ETF Handbook”,https:/.hk/-/media/HKEX-Market/Products/Securities/Exchange-Traded-Products/Launch/HKEX_ETF-Handbook.pdf(accessed on 5 May 2022)3114Case Studies:Infrastructure Enhancements and Their Impact on LiquidityWhile ETFs and market makers

99、contribute positively to enhanced market liquidity,appropriate market mechanism and supporting infrastructure will need to be in place for them to better discharge their functions.Over the years,Hong Kong and other markets across the world have launched a range of effective infrastructure enhancemen

100、ts with an aim of growing market liquidity,including some that were targeting to facilitate ETF trading and/or market making activities.Prior to discussing potential mechanism enhancements for Hong Kong,it would be useful to draw experiences from enhancements previously rolled out in Hong Kong and o

101、ther global markets.On 1 August 2020,the Stamp Office rolled out stamp duty exemption on“sale and purchase of Hong Kong stock involving the activities of ETF market makers in the course of allotting and redeeming ETF shares or units listed in Hong Kong”.32 The initiative,together with other enhancem

102、ent measures on market microstructure,reduced the transaction cost of trading ETFs listed in Hong Kong.This favourable factor has led to more active participation in trading of relevant EFTs.33 As a result,average daily volume of the impacted ETFs increased by 39.7%in the subsequent year,while the t

103、otal average daily volume of the Hong Kong market saw a decline of 4.0%during the same period.Example 1:HKEX Improved liquidity from stamp duty exemption for ETFsFigure 15.Source:Bloomberg1,0008006004002000After(01/08/2020-31/07/2021)Before(01/08/2019-31/07/2020)Average Daily Volume of Impacted ETFs

104、 vs Other ETFs(12 Months Before and After the Stamp Duty Exemption)446340785280474754-4.0%39.7%-37.3%USD(mn)Impacted ETFs(HK Equity with Stamp Duty Exemption)Other ETFsInland Revenue Department Stamp Office,Stamping Circular No.03/2020,(August 2020),https:/www.ird.gov.hk/eng/pdf/sdo/ext_cir/so_ext_-

105、cir_03_2020_e.pdf(accessed on 27 May 2022)Financial Services and the Treasury Bureau(FSTB),Legislative Council Brief,Stamp Duty Ordinance(Chapter 117),Stamp Duty Ordinance(Amendment of Schedule 8)Regulation 2020(13 May 2020),https:/www.fstb.gov.hk/fsb/en/legco/docs/b200513_e.pdf(accessed on 25 June

106、2022)323315Zooming in on the performance of specific ETFs,the liquidity of the Tracker Fund of Hong Kong(2800.HK)increased by 40.2%,the liquidity of Hang Seng China Enterprises Index ETF(2828.HK)increased by 37.1%,and the liquidity of other Hong Kong equity ETFs covered by stamp duty exemption incre

107、ased by 50.6%over the period between August 2020 and July 2021,compared to the preceding twelve months(i.e.August 2019 to July 2020).Taking a closer look at the longer impact of the stamp duty exemption on the Tracker Fund of Hong Kong(2800.HK)and Hang Seng China Enterprises Index ETF(2828.HK and 82

108、828.HK),both funds have experienced an overall sustained growth in terms of trading volume since the introduction of the stamp duty exemption in August 2020.Figure 16.Figure 17.Source:BloombergSource:Bloomberg5004003002001000After(01/08/2020-31/07/2021)Before(01/08/2019-31/07/2020)Average Daily Volu

109、me of Impacted ETFs(12 Months Before and After the Stamp Duty Exemption)642733408838347437.1%50.6%40.2%23USD(mn)Impacted ETFs:2800Impacted ETFs:2828/82828Other Impacted ETFs(HK Equity with Stamp Duty Exemption)39.7%9008007006005004003376427338347038085088471300BeforeAfter200100012 Months Before(01/0

110、8/2019-31/07/2020)12 Months Before(01/08/2020-31/07/2021)24 Months Before(01/08/2021-31/07/2022)Average Daily Volume of Impacted ETFs(12 Months Before and After the Stamp Duty Exemption)USD(mn)28002828+8282816The implementation of a more efficient settlement process can lead to favourable market res

111、ponse.Take the experience in Japan as an example.The Tokyo Stock Exchange streamlined the ETF settlement process in 2021,by smoothening creation/redemption settlement procedures and allowing designated securities companies to use net settlement clearing mechanism for transactions related to ETF crea

112、tion/redemption.By responding to market suggestions,this adjustment has enabled settling a number of transfers between or among counterparties on a net basis.34 As a result of the enhancement,average daily volume of the impacted ETFs increased by 30.8%,while the total average daily volume of the ETF

113、 market saw a decline of 3.1%over the same period.The average daily volume of impacted ETFs as a percentage of market average daily volume increased from 9.7%to 13.4%on average in the six months since the implementation of such enhanced mechanism.Example 2:Tokyo Stock Exchange Improved liquidity fro

114、m streamlined ETF settlement process Figure 18.Figure 19.Source:Bloomberg35Source:Bloomberg362,5002,0001,5001,0005000After(18/01/2021-31/07/2021)Before(01/07/2020-17/01/2021)Average Daily Volume of Impacted ETFs vs Other ETFs(6 Months Before and After)1901,9812,1712481,8552,103-3.1%-6.4%30.8%USD(mn)

115、Other ETFsImapcted ETFs3,5003,0002,5002,0001,5001,000500016%14%12%10%8%6%4%2%0%Jul2021Jun2021May2021Apr2021Mar2021Feb2021Jan2021Jan2021Dec2020Nov2020Oct2020Sep2020Aug2020Jul2020Average Daily Volume(ADV)of Impacted ETFs as a Percentage of Market ADV(6 Months Before and After Streamlined ETF Settlemen

116、t Process)6.6Impacted ETFs ADV as%of Market ADV1,9281601,9512011,7611811,5681412,6572431,8861842,4342661,5091902,1632752,1802951,5402272,1052611,5892191,7732458.3%10.3%10.3%9.0%12.7%13.5%14.7%12.4%13.8%13.8%12.6%10.9%9.8%9.2%BeforeAfterOther ETFsImapcted ETFsBIS,Committee on Payment and Settlement S

117、ystems,“A glossary of terms used in payments and settlement systems”(2003),https:/www.bis.org/cpmi/-glossary_030301.pdf(accessed on 22 June 2022)Only included Japan-listed ETFs with JT tickers on Bloomberg(accessed on 8 August 2022)Only included Japan-listed ETFs with JT tickers on Bloomberg(accesse

118、d on 8 August 2022)343536USD(mn)17Example 3:Enhanced trading environment via self-match prevention mechanisms It is common among market participants to run numerous trading instructions simultaneously.Hence,there is possibility that the markets matching platform could match the buy and sell orders m

119、ade by the same firm.37 With no change in beneficial ownership,such self-matching scenario is unintentional and should be avoided.Implementation of the self-match prevention mechanism is important to enhancing market resilience,facilitating risk management,and upholding market integrity.38 In order

120、to safeguard exchange participants from engaging in unintended self-trading,many exchanges around the world have adopted an optional functionality self-match prevention mechanism,which prevents two orders with the same market participant identifier(MPID)from executing against each other.39 For insta

121、nce,the Nasdaq Stock Market(Nasdaq),Nasdaq BX(BX)and Nasdaq PSX(PSX)offer this optional feature free of charge to their market participants.40 Nasdaq offers three versions of the functionality to allow participants to choose how orders are handled in the event of a self-match situation.41 Advanced s

122、elf-match prevention mechanism promotes more efficient trading,higher quality volume of trades,lower operational costs,and more diverse trading strategies that will contribute to a more resilient ecosystem.With this in mind,many exchanges across the world have adopted self-match prevention mechanism

123、s.Please refer to the Annex 1 for additional information.Source:NasdaqFigure 20.Version 1:DecrementVersion 2:Cancel OldestVersion 3:Cancel NewestIf the orders have the same share size,both orders will be cancelled for the customer.If the orders are not equivalent in size,the smaller order will be ca

124、ncelled for the customer,and the larger order will decrement by the size of the smaller order.The remaining shares of the larger order will remain on the book.Regardless of size,the full size of the order residing on the book will be cancelled for the customer if the incoming order would execute aga

125、inst it.The incoming order will remain intact with no changes.Regardless of size,the full size of the order coming into the book will be cancelled for the customer.The resting order will remain intact with no changes.The Futures Industry Association(FIA),“What is a self-trade,anyway?”(October 2015),

126、https:/www.fia.org/ptg/resources/what-self-trade-anyway(accessed on 22 June 2022)HKEX,“HKEX Investor Presentation”(May 2022),https:/ on 20 June 2022);HKEX,“Building a VibrantTrading Market”,https:/.hk/TuniS/ on 20 June 2022)Nasdaq,“Self Match Prevention”(2018),https:/ Stock Market(Nasdaq),Nasdaq BX(

127、BX)and Nasdaq PSX(PSX)are the three exchanges owned by Nasdaq.Nasdaq is the largest U.S.equities exchange venue by volume and it accepts various order types from clients to execute various trading strategies.Nasdaq BX has an inverted pricing model and provides rebates to liquidity removers in order

128、to execute trades.Nasdaq PSX has a pro rata pricing allocation that encourages market participants to aggressively compete on price.Please refer to Nasdaq,“U.S.Equities,https:/ Trader,“The Nasdaq Stock Market(Nasdaq)”,https:/ Nasdaq PSX is the Most Unique Equity Exchange”(19 April 2017),https:/ acce

129、ssed on 29 June 2022)Nasdaq,“Self Match Prevention”(2018),https:/ on 24 June 2022)373839404118Figure 21.Source:CitadelDespite the costs of putting in place new mechanisms,long term benefits of the enhancements should be recognised.This paper has structured an analysis with a view of assessing the co

130、sts and benefits of implementing such changes.As with other investments,potential monetary involvement would be mostly related to the new or upgrading of the infrastructure,such as systems and networks.Furthermore,some costs may be incurred at different stages of the process,ranging from costs relat

131、ing to piloting,troubleshooting,and maintenance.In addition,in view of the new processes and rules needed alongside the develop-ment,training support offered to staff will be crucial.However,monetary involvement in these invest-ments can be gradually amortised over the years while bringing significa

132、nt favourable impact.The enhancements will improve trading efficiency for investors and reduce risk exposures arising from the settlement process.We envisage that developing our market into a more advanced trading venue will bring various benefits.For instance,the enhancement will induce more and a

133、wider varie-ty of market players to utilise our platforms,which will in turn lead to a more robust and dynamic investment environment,and thereby creating more job opportunities and stronger growth of the economy.In the long term,the enhancements will promote the overall market vitality and trading

134、quality,resulting in better liquidity and will further improve Hong Kong market competitiveness among other global markets.Cost benefit analysis of infrastructure enhancementsHelpsIncreaseLiquidity?EncourageeDiverseStrategies?ReduceOperationalCostsReducesComplexityGlobalUtilisationCancelBothDecremen

135、tCancelMatch DontPrintCancelPassiveCancelAggressiveLowMediumLowVery HighLowReducesOperational RiskSelf-Match Prevention Overview19Potential Measures to Enhance Market LiquidityA markets liquidity is a crucial deciding factor as investors,issuers and other participants consider where to take part in

136、financial market activities.Through our exploratory exercise,increasing popu-larity of ETF investment is observed in developed markets,due in part to its cost-effective character-istics and diversification benefits.With increased investor interests,the liquidity of ETF underlying assets is enhanced,

137、and such positive impacts can be further boosted with the facilitation and sup-port of market makers.With the aim of enhancing liquidity of the Hong Kong market,this paper sets out a set of recommendations-adopting a multi-pronged approach to facilitate ETF trading activi-ties,to enhance current rul

138、es and incentive programmes in relation to trading and clearing,as well as to upgrade the trading infrastructure.With the enhancements of ETF trading activities and introduction of market makers as key points of reference,recommendations set forth in this paper are put together to tackle specific is

139、sues faced by ETF operators or market makers.Such enhancements will also be timely for the development of the newly launched ETF Connect.We believe that these proposals will enable ETFs and market makers to better discharge their market function as liquidity providers;these suggestions will,together

140、,create a virtuous cycle that can enhance market liquidity,and cement Hong Kongs competitiveness as an international financial centre.Over the last few years,HKEX has introduced various mechanisms to foster market development through facilitating market participants,market makers and ETFs to better

141、perform their roles.FSDC recommends HKEX to consider building on these successful initiatives and rolling out further enhancement measures that can bring immediate positive impacts to the trading of ETFs and,hence,the market.These suggestions,among which,are with lower barrier to accomplish.These su

142、ggestions include:1.Introducing a new spread table with tick sizes more suitable for Hong Kong-listed stocksIntroducing a spread table that sets out the minimum price movements(i.e.tick intervals)for securities to trade at different price ranges.42 Smaller tick size leads to greater flexibility,bett

143、er price efficiency,and potentially lower trading cost.43 In February 2020,HKEX introduced a new spread table with reduced tick sizes for ETFs and Leveraged and Inverse Products to create greater trading flexibility for investors.44 While the adjustment was well received by the market,it is worth no

144、ting that single stocks are still traded in accordance with the old spread table,which not only leads to investors paying higher spreads for single stocks trading,but also results in ETF market makers having to mark-up ETF quotations to cover for the higher stock spreads.In this context,HKEX should

145、explore introducing a new spread table with tick sizes more suitable for Hong Kong-listed stocks at different prices to align with the latest market development.This can reduce price spreads when market makers offer ETF pricing to investors,lower trading costs for market participants,enhance flexibi

146、lity and price efficiency for investors when faced with various unexpected market conditions,and,ultimately,increase ETF market liquidity.Adjustments should be made based on price range to ensure the new spreads are suitable for stocks within different price ranges.Enhancements of ETF trading activi

147、tiesHKEX,Exchange Traded Product Investors,https:/.hk/Products/Securities/Exchange-Traded-Products/Investors?sc_lang=en(accessed on 20 June 2022)HKEX,“Introducing smaller tick size to Hong Kong ETFs”,https:/.hk/-/media/HKEX-Market/Products/Securities/Exchange-Traded-Products/Launch/HKEX-Exchange-Tra

148、ded-Product-Introducing-Smaller-Tick-Size-to-Hong-Kong-ETFs-infosheet.pdf(accessed on 21 June 2022)HKEX,“Circular:Introduction of new spread table and continuous quoting market making obligations for Exchange Traded Funds and Leveraged and Inverse Products-Update”(27 February 2020),https:/.hk/-/medi

149、a/HKEX-Market/Services/Circulars-and-Notices/Participant-and-Members-Circulars/SEHK/2020/ETP_00220_e.pdf(accessed on 5 May 2022)424344202.Increasing maximum spread range requirement to above 24 spreadsAn ETF has two prices,namely the one measured by its net asset value(NAV),which represents the esti

150、mated“fair value”of its underlying securities,and the market price on the exchange where the ETF can be bought or sold by investors within trading hours.45 These two prices might be different from each other depending on market conditions(e.g.price discrepancy tends to be larger when markets and sen

151、timents are more volatile).Market makers play a major role in restoring the ETF back to its fair value when the ETF is trading at a premium(i.e.when demand is higher than supply)or discount(i.e.when supply is higher than demand)by setting a bid price and an ask price in and around the ETFs intra-day

152、 NAV.According to the current the HKEX trading rules,the maximum spread range allowed for equities and ETFs is 24 spreads when trading on-screen.46 However,this spread might not be significant enough for market markets to trade under certain market conditions,especially when the market becomes overl

153、y volatile.For example,if an aggressive investor wants to sell a large lot of ETFs,the investor will then have the ability to drive down the price.That said,under the current rules,a market maker can only price the sale of the ETF within 24 spreads,which may not be sufficient for the market maker to

154、 hedge all potential risks and provide a buffer for holding the inventory.More specifically,if the average daily volume of one ETF is 100,000 units and one seller wants to sell 10,000,000 units,market makers may need months to unwind their positions on-screen,which requires more buffer on pricing to

155、 hedge the risk.HKEX may consider increasing the maximum premium/discount requirement to above 24 spreads under certain circumstances as appropriate,while other measures can be put in place to prohibit certain behaviour intended to disrupt market orders.For instance,when the market is volatile or fa

156、cing considerable uncertainties,a wider pricing difference for official market makers of ETFs can facilitate the execution of large volume trades in volatile markets.This will,in turn,facilitate trading efficiency in the secondary market and enhance liquidity for the larger financial market.3.Extend

157、ing the market maker short-sell permission for manual tradesIn Hong Kong,market makers are unable to provide liquidity outside the continuous trading sessions with exemptions such as short selling,tick rule,stamp duty,etc.;this arrangement hinders their market making functions.For instance,if a clie

158、nt reaches out to a market maker to buy a specific ETF at 5pm when the HKEX market is closed,the market maker will not be able to match the trade unless the market maker has sufficient inventory.In other markets,such as the US,short sell exemption is allowed round the clock(i.e.24/7).The permission

159、to short sell will incentivise a market participant to become a market maker.Short selling,apart from being a fundamental function of market makers,also allows further flexibility to the participant and provide it an alternative channel to generate profit.HKEX may consider extending the short sell p

160、ermission for market makers to manual trades(OTC trades after-market hours),which will unlock an important market making function of market makers,allowing them to provide more ETF liquidity during non-continuous hours and improve ETF liquidity on the following days.HKEX,“ETF Handbook”,https:/.hk/-/

161、media/HKEX-Market/Products/Securities/Exchange-Traded-Products/Launch/HKEX_ETF-Handbook.pdf(accessed on 5 May 2022)HKEX,Securities Market Operations,https:/.hk/Global/Exchange/FAQ/Securities-Market/Trading/Securities-Market-Operations?sc_lang=en#collapse-8(accessed on 27 May 2022)4546214.Introducing

162、 adjustments to ETF settlement approachesSettlement approaches can affect market makers effectiveness to create liquidity.On the ETF primary market,where market makers create or redeem ETF units for securities and/or cash,market makers are required to a)perform Free of Payment(FOP)settlement47 on T

163、or T+1 for the creation orders,and b)obtain ETF units at T+2 through one of the four settlement batches(i.e.10:30 a.m.,12:00 noon,2:00 p.m.and 3:45 p.m.).In practice,as it may not be clear or even unknown as to which batch the ETF unit may be settled through,GCPs and counterparties usually require m

164、arket makers to prefund and transfer funds on T+1.This practice,though not a requirement,would adversely impact the utilisation and deployment of capital among market makers,resulting in higher costs(e.g.funding cost,opportunity cost)and risks(e.g.liquidity risks,market risks).The ripple effect woul

165、d lead to pass-on costs to investors and discourage investors from trading in Hong Kong.It is believed that if ETFs can settle through Delivery Versus Payment(DVP),it can lead to better market liquidity than using FOP.DVP refers to“a securities settlement mechanism that links a securities transfer a

166、nd a funds transfer in such a way as to ensure that delivery occurs if and only if the corresponding payment occurs”.48 Settlement made through DVP will mitigate the risk that securities are transferred but payment are not received,or vice versa,as payment and securities are settled simultaneously.4

167、9 Considering the above,HKEX is recommended to set clearer guidance and allow ETFs to settle through DVP on T+2,or through one batch of settlement at T+2 afternoon.Free of Payment refers to“a transfer of securities without a corresponding transfer of funds”.Please refer to BIS,https:/www.bis.org/cpm

168、i/publ/d00b.htm?&se-lection=128&scope=CPMI&c=a&base=term(accessed on 29 May 2022)BIS,https:/www.bis.org/cpmi/publ/d00b.htm?&selection=26&scope=CPMI&c=a&base=term(accessed on 29 May 2022)BIS,Committee on Payment and Settlement Systems,Technical Committee of the International Organization of Securitie

169、s Commissions,“Recommendations for securities settlement systems”(November 2001),https:/www.bis.org/cpmi/publ/d46.pdf(accessed on 21 June 2022)47484922A General Clearing Participant is“a participant who registers and clears trades for its own and clients accounts and on behalf of non-clearing partic

170、ipants”.Please refer to HKEX,Becoming a HKCC Participant,https:/.hk/Services/Clearing/Listed-Deriva-tives/Getting-Started/Becoming-a-HKCC-Participant?sc_lang=en#:text=General%20Clearing%20Participant%20(%22GCP%22,behalf%20of%20Non%2DClearing%20Participants(accessed on 29 May 2022)50It is recommended

171、 that HKEX should assess the suitability of current rules and incentive programmes in relation to trading and clearing,and introduce adjustment where necessary,with a view to addressing challenges caused by legacy issues.By referring to global best practices,it will ensure that the Hong Kong market

172、can provide a competitive level of ease and convenience to participants,which will maximise growth potentials of the overall market.Some recommendations are as follows:1.Introducing new rules that allow market makers to engage multiple clearing participantsHaving flexible and effective clearing arra

173、ngement in place would ensure market makers that they could conduct trading in a safe and efficient manner.Based on rules set out by HKEX,each market maker in Hong Kong can only settle trades with one clearing participant,also known as General Clearing Participant(GCP),50 which could result in high

174、concentration risks.Such a practice is different from the treatment for hedge funds,who also trade frequently but are allowed to have multiple prime brokers to diversify risk exposures.Such a practice also allows hedge funds to move their asset holdings among prime brokers to manage risks based on p

175、revailing market conditions.With only a few eligible GCPs in the market,market makers choice of GCP is limited and,as a result,embedded risks are highly concentrated.In the event of extreme market events such as those happened during the global financial crisis,market makers could be significantly i

176、mpacted.This creates an unfavourable impact on market makers ability to provide liquidity in Hong Kong,as internal risk management procedures usually limit the number of trades that can be dealt with by one GCP despite this may not be required by rules or regulations.HKEX may consider allowing marke

177、t makers to clear with multiple clearing participants(i.e.allowing a multiple-GCP system on the exchange level),with each clearing participant making required reporting.Allowing multiple GCPs will help market makers reduce concentration risks,and it will also provide market makers the flexibility to

178、 choose suitable clearing participants.This arrangement will liberalise the market through introducing further competition among GCPs,which will in turn lead to further enhancement of the overall market competitiveness.2.Assessing portfolio risks of market participants across the central counterpart

179、iesThere are three central counterparties(CCPs)supporting activities at HKEXs two exchanges(i.e.The Stock Exchange of Hong Kong and Hong Kong Futures Exchange Limited).These three CCPs are,namely,Hong Kong Securities Clearing Company Limited(HKSCC),HKFE Clearing Corporation Limited(HKCC),and the SEH

180、K Options Clearing House Limited(SEOCH).While many investors hold portfolios across all three CCPs,margins are calculated based on each of the portfolios held under the three CCPs separately,without any regard to the overall position held by an investor.From the market makers perspective,this practi

181、ce creates inefficiency in terms of capital usage,resulting in higher costs that limits the market makers ability to provide liquidity in the market and poses higher inventory risk,especially at times when market are volatile.To address these issues and provide further incentives to attract market p

182、articipants,HKEX may consider assessing portfolio risks of participants across CCPs to optimise capital efficiency for clearing and trading participants.Enhancements of general trading and clearing activities233.Considering market maker programmes for illiquid stocks to improve liquidityAs previousl

183、y mentioned,market maker is a key liquidity provider and one of their obligations is to conduct high-volume trading that covers a wide range of securities,including ETFs,to provide liquidity and will,in return,be compensated via incentives such as fee rebates.Such a practice is widely adopted in dev

184、eloped markets and the HKEX also uses market makers.In spite of existing incentive schemes offered to market makers by HKEX,51 such as discounted trading fee or 100%trading fee waiver or rebate,a significant number of securities remain relatively illiquid in the market.Through using the trading of E

185、TF as a point of reference,HKEX may take Hong Kongs market characteristics into account and introduce market making incentives targeted at low-liquidity securities with practical standards.For example,in the Japanese market,one of the incentives provided by the stock exchange is that,if the market m

186、akers are to trade one of the lowest liquidity securities as reflected on a certain list,they will be able to enjoy more attractive incentives(e.g.cash rebate)compared to trading the highest liquidity securities.52 HKEX,Market Making/Liquidity Providing Obligations and Incentives,https:/.hk/Products

187、/Listed-Derivatives/Market-Maker-Program/Market-Maker-Obligations-and-Incentives?sc_lang=en(accessed on 27 May 2022)Tokyo Stock Exchange,“Handling of ETF Market Making Incentive Scheme”(June 2022),https:/www.jpx.co.jp/english/equities/products/etfs/mar-ket-making/b5b4pj000001zbcx-att/b5b4pj0000020mq

188、m.pdf(accessed on 20 July 2022)515224To cement Hong Kongs competitiveness and comprehensiveness as not only a world-class listing market,but also a premier trading market,HKEX should continue to embrace technological advancement as part of its long-term strategy and strive to enhance its trading sys

189、tem and increase market transparency.A vibrant secondary market with ample liquidity will,in turn,play into providing stronger support for Hong Kongs primary market to reach greater heights.It is recommended that the HKEX to consider allocating more investment in upgrading infrastructure.1.Adopting

190、an opt-in self-match prevention mechanism by the HKEXAs discussed in the previous section of this paper,many exchanges in both developed and emerging markets have adopted self-match prevention mechanisms to reduce unintentional,frictional and other transaction costs.Self-match prevention mechanisms

191、are vital to making an exchange more robust,by boosting higher quality volume and encouraging diverse trading strategies which contribute to a more resilient ecosystem.Currently,there are no self-match prevention mechanisms for equities on HKEX.Considering international practices and Hong Kongs fund

192、amental market structure,HKEX should consider adopting an opt-in self-match prevention mechanism with reference to self-match prevention rules of other exchanges,such as those in the US and other markets.Some self-match prevention rules may reflect such practices adopted by Nasdaq as detailed on P.1

193、8.2.Providing higher transparency on picked gateways connecting members and exchangesCurrently,information on which gateway(s)is(are)allocated during the time of trading through the matching engine53 is not transparent enough in Hong Kong.In other markets(e.g.US),information such as the general numb

194、er of gateways,which gateway connections for each market are chosen during each trade,and the rule of how gateways transmit data,is disclosed and can easily be retrieved by market participants.Among others,HKEX may consider changes in three main areas:Upgrade of infrastructure and systemsdisclose mo

195、re details on how the technical infrastructure is designed,including information on network/gateways/matching engine/information servers,etc;maintaining a single first-in-first-out gateway with advanced time-stamping technology to minimise gaming of timing;and making available a single session per s

196、ymbol-gateway switch for each client to reduce variability and prevent a race of infrastructure expenditure by sophisticated participants.a)b)c)A technology that matches bids and offers to execute trades,according to Nasdaq,Trade Matching System,https:/ on 31 May 2022)53253.Upgrading trading system

197、with advanced technology accompanied with capacity buildingIn the face of the constantly evolving technology landscape,it is widely recognised that regular system upgrades are necessary to keep up with changing client needs and stay relevant in the global competition.In this regard,when compared wit

198、h other major global exchanges,more proactive actions would be appreciated.To strengthen the competitiveness of its service offerings,HKEX should continue to develop and upgrade its trading systems,preferably with the most advanced technology that supports optimal electronic mechanisms and infrastru

199、cture.As such upgrades are incorporated,HKEX should structure comprehensive and detailed capacity building plans for market participants and stakeholders,as they will support them in making informed decisions and seizing opportunities that they are less familiar with.26ConclusionHong Kong is no doub

200、t the leading international financial centre in the Asian time zone,with its fundraising capabilities being often cited as the obvious strength of its financial market.This study is conducted with a view of further strengthening our ecosystem,looking into ways to further enhance our market liquidity

201、 and boost the secondary market trading activities.Liquidity,together with other market factors,determines whether trades can be executed efficiently and in a cost-effective manner,and it is a key factor for investors as they consider where to operate.Therefore,Hong Kongs ability to constantly impro

202、ve market liquidity is crucial to the sustainable development of the market.To this end,the FSDC,through engagement with subject matter experts,proposes recommendations that are considered useful in enhancing the overall market liquidity.Through these enhancements,we believe ETFs and market makers,w

203、ho are key market participants and liquidity providers in developed market,can better play their role in boosting liquidity and nurturing a more favourable trading ecosystem.27Appendices Appendix 1.Maker makers sources of profit In general,market makers generate revenue from two sources:(i)trading(s

204、elling and buying)and(ii)holding particular assets.While market makers infuse liquidity into a market by buying and sellingsecurities,they generate revenue at the same time from taking the arbitrage of such differencesbetween the bid and ask price on their trades.Another source of revenue comes from

205、 net changesin the value of assets held in inventory,in addition to accrued interests.54 Profits of market makerscan then be derived by adding these revenues together with a deduction of costs incurred on trading,funding,hedging,etc.Additionally,market makers should take note of the inventory risk i

206、n view ofthe possible price fluctuations on holding assets.Figure 22.Source:BISRevenue:Spread of bid-ask quotes;asset held in inventory HowCost:Incurred on trading/funding/hedgingProfitArbitrages-index arbitrage/fixed income arbitrage/volatility arbitrage,etc.Inventory risk management-using stocks,o

207、ptions,futures contracts,or other derivativesBIS,BIS Quarterly Review,“Shifting tides-market liquidity and market-making in fixed income instruments”(March 2015),https:/www.bis.org/publ/qtrpd-f/r_qt1503i.pdf(accessed on 23 June 2022)5428ExchangeSMP Implementation DateCboe BZX EquitiesNasdaq OptionsN

208、asdaq BXNYSE Arca(CA,CP,CD,CB)Cboe BZX OptionsCboe BYX EquitiesEDGA EquitiesEDGX EquitiesCboe OptionsCboe C2 OptionsMIAX OptionsNYSE(CA,CP)NYSE American(CA,CP)CME(CA)ICECboe Futures(CFE)CME(CA,CP)Nasdaq PHLXCboe EDGX OptionsMIAX PearlNYSE American(CA,CP,CD,CB)NYSE Chicago NYSE National Nasdaq ISENas

209、daq MRXNasdaq GEMXMIAX EmeraldNYSE(CD)2008200920092009201020102010201020112011201220132013201320132014201420142015201720172017201820182018201820192021Appendix 2.Markets that have implemented self-match prevention mechanisms on multiple exchanges since 2008(by region)America29Source:Respective Exchan

210、gesExchangeSMP Implementation DateCboe Australia(CA,CP,DC,CB)ASXJNXCboe JapanNSEBSESGX-DTOSEHKFETSENZXSGX-ST(to be launched)SET(to be launched)KRX(to be launched)20112013201320142015201520162019201920212021To be launched in late 2022Platform upgrade planned for 2023Platform upgrade planned for 2023A

211、PACEuropeExchangeSMP Implementation DateCboe EuropeTurquoiseLSEBorsa ItalianaEuronext CashNasdaq OMX CashSIXXetraEurexNasdaq OMX DerivativesIDEMBME20092013201320132014201420152015201520152016202030*CA=Cancel Aggressive(Incoming),CP=Cancel Passive(Resting),CB=Cancel Both,CD=Cancel&DecrementSource:Res

212、pective ExchangesThe operation of the FSDC is led by:Dr King AuExecutive DirectorThis report was duly prepared by the FSDC Policy Research Team:Dr Rocky Tung Director,Head of Policy ResearchMs Wivinia Luk Senior Manager,Policy ResearchMs Jessie ChenManager,Policy ResearchMs Joyce LeeManager,Policy R

213、esearchMr Kendrew LeungManager,Policy ResearchMr Clement HoAssistant Manager,Policy ResearchMs Mickey SzeAnalyst,Policy ResearchAcknowledgementExecutives of the following firms and organisation have provided valuable and constructive suggestions to this Paper:Alternative Investment Management Associ

214、ationCitadel SecuritiesCSOP Asset Management LimitedEuroclear Bank Hong Kong BranchFlow Traders Hong Kong LtdOptiver Trading Hong Kong LtdUBS Hong Kong BranchThe FSDC would also like to thank Ms Melody He and Ms Lulu Shu for their contributions to this Paper.Report WeblinkWeblink to the pdf version

215、of this reportFSDC WeblinkFinancial Services Development CouncilThe FSDC was established in 2013 by the Hong Kong Special Administrative Region Government as a high-level,cross-sectoral advisory body to engage the industry in formulating proposals to promote the further development of the financial

216、services industry of Hong Kong and to map out the strategic direction for the development.The FSDC has been incorporated as a company limited by guarantee with effect from September 2018 to allow it to better discharge its functions through research,market promotion and human capital development with more flexibility.Contact usEmail:enquiryfsdc.org.hkTel:(852)2493 1313 Website:www.fsdc.org.hkAbout the FSDC