Published On: Fri, Jan 14th, 2011

Implementation of HKEx’s Strategic Plan 2010-2012

HKEx’s major challenges and priorities

Hong Kong Exchanges and Clearing Limited (HKEx) has begun the second year of its Strategic Plan 2010-2012, focusing on three key components: accelerating its platform infrastructure upgrade and necessary market structure reforms, reinforcing its position as a global listing venue by promoting international listings, and developing its renminbi (RMB) capability and Mainland compatibility.

HKEx anticipates significant challenges in pursuing these strategic initiatives in 2011 while at the same time maintaining its operational excellence and system reliability. With inherent conflict between those objectives, the key is to determine when HKEx might be moving too fast or not fast enough. Development pace cannot be at the expense of system stability and market readiness; but an overly conservative approach could result in loss of critical strategic opportunities, especially in today’s highly competitive environment and rapidly changing industry landscape.

While HKEx will strive with full effort to achieve the most optimal outcome, it should also recognise that there is no magic formula for striking the perfect balance and that no option is risk free or cost free.

Below are HKEx’s major plans for the coming year and beyond:

Improvements to Platform Infrastructure and Market Structure

1. Extension of trading hours in two phases
HKEx is now preparing internally for the implementation of the first phase which is scheduled to begin on 7 March this year. The second phase is scheduled to be implemented on 5 March 2012. HKEx believes the proposed changes will improve the price discovery function for Mainland-related securities by increasing the overlap of trading hours with Mainland exchanges. This will also strengthen HKEx’s competitiveness by narrowing the gap between its trading hour duration and those of regional and global competitors.

2. After-hours trading of futures and options
HKEx has been conducting a study and soft consultation with market participants on the trading of futures and options after their current market close. Initial feedback has been encouraging. After-hours futures and options trading would help improve execution efficiency and trading arrangements, which is one of HKEx’s key initiatives in its Strategic Plan 2010-2012. HKEx plans to publish a consultation paper to seek market views on the proposal in the middle of this year.

3. Review of risk management regime
One of HKEx’s strategic initiatives is to develop proposals to enhance clearing house capital adequacy and improve the securities market’s risk management and access to liquidity to meet its current and future needs, particularly in light of HKEx’s growing business and experience with market volatility. HKEx also aims to more closely align its clearing houses with international standards and best practices.

HKEx conducted an internal review of risk management measures last year and proposed improvements which were approved in principle by the Board in November of last year. In addition, it has obtained additional banking facilities to enhance the clearing houses’ liquidity.

HKEx is in discussions with the Securities and Futures Commission (SFC) and aims to consult the market in the second quarter this year on the clearing houses’ stress test assumptions, funding model and securities market margin requirements.

HKEx strongly believes that the funding model must be fair and reasonable for all market participants and not hinder the competitiveness of its markets.

4. OTC clearing
HKEx decided last month to establish a clearing house by the end of 2012 for derivatives traded in Hong Kong’s over-the-counter (OTC) market to support global regulatory initiatives and take advantage of business opportunities in OTC derivatives clearing. While OTC clearing is a relatively low-volume market in Hong Kong at the moment, HKEx sees strategic value of introducing the service as it will bring new business, new revenue, a new Participant base and new products. In addition, HKEx believes the business has tremendous potential for growth, particularly with the wider use of RMB in international transactions. HKEx plans to make an initial investment of $180 million in the new clearing house using internal resources.

5. Securities and derivatives market system capacity and technology upgrades
The upgrade to the securities market trading system (known as AMS/3.8) aims for a 10-fold improvement over the existing securities trading system capacity to achieve an initial capacity of 30,000 orders per second (scalable to 150,000 orders per second if necessary), as well as an average order processing latency of nine milliseconds, to deliver significant advancement in the capacity and performance of the securities market infrastructure. HKEx expects the upgrades to be completed by the end of this year.

The upgrade to the securities market data system (also known as MDS/3.8) will increase the throughput for market data dissemination to 2,000 stock page updates per second from 1,000 stock page updates per second at present.

AMS/3.5 vs. AMS/3.8

Capacity
(orders per sec)

Latency

AMS/3.5 (current)

3,000

~150 ms

AMS/3.8 (initial)

30,000

9 ms

AMS/3.8 (if fully scaled up)

150,000

9 ms

Millisecond is a thousandth (1/1,000) of a second.
AMS/3.8 will be introduced by the end of this year.

MDS/3.5 vs. MDS/3.8

MDS/3.5

Update rate/sec

Latency

Protocol

Standard Level-2 with 5 depths (current)

1,000

500 ms

Unicast

MDS/3.8 (initial)

Standard Level-2 feed with 10 depths

2,000

100 ms

Unicast

MDS/3.8 (new, 6 to 9 months after launch)

Low latency Level-2 feed with 10 depths

4,000

50 ms

Multicast

Streaming full depth feed

10,000

25 ms

Multicast

Phase 1 of the capacity and technology upgrade of the derivatives market trading and clearing systems, HKATS and DCASS, was rolled out last October to increase the order capacity of HKATS to 21,000 order book changes/second (OBC/S) from the original of 8,100 OBC/S. The design of the DCASS software will be enhanced in Phase 2 and rolled out in the middle of this year.

6. Next Generation Data Centre and hosting services
In 2010, HKEx started preparatory work to build its Next Generation Data Centre (NGDC) in Hong Kong’s Tseung Kwan O Industrial Estate. The NGDC will consolidate the primary data centres for all of HKEx’s markets and clearing houses’ systems, as well as certain IT development and support staff. HKEx currently has primary data centres in two separate locations in Hong Kong and backup centres in three other locations in the city. The NGDC will be built to meet the highest level of resilience, targeting top-level Tier 4 data centre requirements, and the LEED Gold standard, which is part of an internationally recognised green building certification system.

In November of last year, the Board decided that HKEx would offer Hosting Services, including low-latency co-location with HKEx markets, at the NGDC. The Hosting Services business is expected to provide up to 1,200 cabinets of server space at an average power allocation of 6KVa per cabinet.

HKEx aims to build an ecosystem in which HKEx systems, Exchange Participants (EPs), Information Vendors (IVs), technology vendors and telecommunication providers are members. Operational support for hosted customers will be provided.

In the ecosystem:

* EPs can connect to HKEx’s trading systems while IVs can connect to HKEx’s market data systems, which means low latency co-location with HKEx markets will be permitted and low-latency HKEx market data can be provided by hosted IVs;
* There will also be international market data feeds offered by the IVs hosted in the NDGC;
* Technology vendors hosted in the NGDC may offer their technical platforms, such as market gateways, Broker Supplied System software, order management systems, algorithmic trading engines, and so forth, to EPs;
* Telecommunication providers can also connect into the data centre; such connectivity will facilitate global telecommunications lines that can be used to connect to other financial markets directly from the NGDC;
* Connectivity to regional and global marketplaces will allow Hosting Services customers to connect to other financial markets through shared lines, reducing or eliminating the need for them to build dedicated communications links.

The offering of Hosting Services is in line with the latest global exchange industry trends and market feedback in Hong Kong has indicated a strong desire for value-added Hosting Services. HKEx is confident that its Participants and other constituents will see the benefits of the endeavour.

In order to fully complete the NGDC and ensure its power capability to support Hosting Services, the relocation of HKEx’s securities market systems is now scheduled for the fourth quarter of 2012. The tentative target for completion of the relocation of other HKEx systems, such as the derivatives market systems and clearing systems, to the NDGC is the fourth quarter of 2013. Installation of mechanical and electrical facilities for the provision of Hosting Services will be conducted in phases as needed and may be extended beyond 2013.

7. Implementation of the scripless market model
The consultation conclusions were published on 21 September of last year. The SFC will consult the public this year on new subsidiary legislation that will set out in more detail how the scripless environment and those that play a key role in that environment will be regulated. A scripless regime will be implemented in phases following the necessary legislative changes and when the market infrastructure, key operators and market participants are ready. The first phase of the scripless regime is expected to be implemented in late 2013.

8. Execution at market close
HKEx will explore possible options to enable execution at market close in view of market needs and based on its experience. Any future proposals will be put forward for public consultation before implementation. There is no timetable for this initiative at the moment.

9. Narrowing of trading spreads
HKEx continues to review its trading environment from time to time and endeavours to enhance the efficiency and liquidity of its markets. It does not have a timetable for this initiative at this point.

10. Trading anonymity
While Hong Kong has a long tradition of showing broker identity on securities trading screens, HKEx is aware of some market participants’ suggestions about providing broker anonymity in its securities market’s electronic trading system, which processes all transactions. HKEx will closely monitor developments in other international markets and will carefully consider whether any changes are necessary. It does not have a timetable for this initiative at this point.

11. Direct market access
Some brokers provide designated connections for specific clients and these clients can send orders directly to HKEx’s trading systems. In order to understand the market practice and development trend as well as the possible impact on our marketplace, HKEx will study direct market access related activities in its market and will work with the SFC to ensure best practices have been adopted by sponsoring brokers.

12. Unification of clearing houses

HKEx is analysing the cost and benefits of unifying its clearing houses. This is a complex project which will require careful, in depth consideration. HKEx needs to be sure consolidation would be in the best interest of the markets and Participants before proceeding. The market can rest assured that all key stakeholders will be consulted at the appropriate time.

Global Listing Venue

HKEx will continue to focus on providing a quality equity market for issuers and investors. HKEx welcomes applications from all companies interested in listing in Hong Kong provided that they are able to meet its listing requirements.

In addition to holding listing promotion events in the Mainland, HKEx will continue to visit overseas markets to promote the benefits of listing in Hong Kong. It has planned several overseas trips this year to promote its markets, including visits to Australia, Canada, Europe, Indonesia, Japan, Korea, Mongolia, Kazakhstan, Russia, South America and Taiwan.

HKEx plans to expand its international listing base further by accepting more overseas jurisdictions as places of incorporation for listed issuers, including India and South Africa. Last year, the Listing Committee approved the US State of California, Brazil, the Isle of Man, Japan and Italy as recognised jurisdictions, bringing the total number of recognised jurisdictions to 15. This is in addition to the four jurisdictions stipulated in the Listing Rules, namely Hong Kong, Mainland China, Bermuda and the Cayman Islands.

To beef up its issuer marketing team, HKEx recently appointed Eric Landheer as Head of Issuer Marketing in its Market Development Division. Mr Landheer will join HKEx on 1 February.

Development of RMB Capabilities

1. RMB liquidity pool
RMB-denominated securities could be listed and traded without a special RMB liquidity pool.

HKEx however believes it is important to establish a solid mechanism to facilitate the listings of RMB-denominated shares in Hong Kong, rather than having several listings of RMB-denominated products in which trading in the secondary market may be hindered by the limited RMB liquidity here.

HKEx is exploring the feasibility of developing an RMB liquidity pool to assist investors who do not have RMB to invest in RMB-denominated securities. Such a mechanism would also facilitate the listing of RMB-denominated products in Hong Kong. HKEx is working with banks on foreign exchange and other treasury arrangements for a RMB liquidity pool. A timetable has not yet been determined but HKEx hopes a liquidity mechanism can be introduced in the second half of this year.

2. RMB-related products
HKEx is preparing its systems for RMB-related products, including RMB futures. HKEx is currently in discussions with potential market makers for RMB futures to explore ways to connect their forex trading systems to its trading system.

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