In the pulsating world of global finance, one key player is conspicuously absent in Hong Kong’s stock market landscape: the equity Market Maker. These behind-the-scenes heroes are integral to exchanges from Wall Street to London, ensuring that transactions flow smoothly and swiftly. They’re the architects of liquidity, bridging the gap between buyers and sellers, and instilling confidence in investors. Yet, in Hong Kong, while derivatives Market Makers are active, equity Market Makers are not permitted to operate. This lack of equity Market Makers leaves small and mid-cap companies to grapple with low trading volumes and liquidity challenges. This article aims to shed light on the vital role Market Makers play in global stock exchanges and why their acceptance could bring benefits Hong Kong’s financial market, especially for its smaller listed companies.
What is Market Making?
Market Making involves firms or individuals providing both buy and sell quotes for a financial instrument, essentially ‘making the market.’ By doing so, they facilitate trade even if there isn’t a direct buyer or seller, ensuring there’s always a price for an asset. They bridge the gap between buyers and sellers and earn from the bid-ask spread difference.
The Role of Market Makers:
- They ensure fluidity in financial markets, which instills confidence among investors.
- Market Makers always maintain a ready stock of securities to facilitate immediate trade demands.
- Their commitment is not just in price but also in the volume and frequency of their quotations, especially during volatile market situations.
Shares and Product Selling – The Unseen Parallel:
At its core, selling shares is akin to selling any product. Just as products need marketing and promotion to find buyers, shares too, especially of lesser-known firms, require their own form of ‘promotion’ to reach potential investors. This is where Market Making steps in, acting as the bridge between potential buyers and sellers.
Global Acceptance of Market Making:
Market Making is not a new phenomenon. Established exchanges, notably in the US and UK, have permitted and nurtured Market Making activities for years, recognizing their pivotal role in ensuring a liquid market. Moreover, countless other countries globally have embraced Market Making as an indispensable tool for their financial ecosystems.
From the US’s NYSE and Nasdaq, Germany’s Frankfurt Stock Exchange, the London Stock Exchange Group, to the Tokyo Exchange Group and Toronto Stock Exchange, Market Makers are a global phenomenon. Renowned names include:
· US: Credit Suisse, Goldman Sachs
· Germany: Berenberg, JPMorgan
· London: BNP Paribas, Standard Chartered
· Tokyo: ABN AMRO Clearing, Nomura Securities
· Toronto: BMO Nesbitt Burns, TD Securities
A Boost for Hong Kong Market Makers:
In January 2023, HKD-RMB Dual Counter Model commenced with the introduction of Dual Counter Market Maker (“DCMM”). With the government’s recent waiver of stamp duty on dual-counter stock transactions, DCMM in Hong Kong stand to obtain significant advantages. These include:
· Reduced Transaction Costs: The previously levied stamp duty, which constituted over 90% of transaction costs, will now be eliminated for certain trades, leading to sizable savings.
· Increased Liquidity: The move is expected to entice more participants to the HKEX’s DCMM Programme, enhancing market liquidity and efficiency.
· Growth Opportunities: As transaction barriers decrease, market makers can explore new strategies, like arbitrage trading, with reduced overhead, further amplifying their potential profits.
Diving Into the Liquidity Figures: A Hong Kong vs US Comparison
In 2022, data from the Financial Services Development Council revealed that Hong Kong’s market liquidity registered at 62.4%, a metric assessed by turnover liquidity — the correlation between the traded value and the overall market capitalization. However, this figure lags behind the US, where a combination of the Nasdaq and the New York Stock Exchange churns out a turnover liquidity of more than 100%.
So, what fuels this disparity between the liquidity of Hong Kong and the US markets? Delving deeper into the trading patterns, institutional investors have a stronghold over Hong Kong’s cash market, commanding 56.4% of its turnover in 2020. These institutions don’t trade as actively as market makers, high-frequency traders (HFTs), or quantitative funds. The latter group is responsible for 28.1% of Hong Kong’s trading volume.
Contrast this with the US scenario: it’s a dramatically different landscape. High-volume traders dominate, with market makers, HFTs, hedge funds, and quantitative funds jointly accounting for a whopping 67.9% of market turnover. This underscores the pivotal role such traders play in boosting liquidity and explains the yawning gap between the two regions.
Who Benefits the Most from Market Making?
Interestingly, while one might assume that major players or large-cap listed companies would be the main beneficiaries, it’s the smaller to medium-sized listed firms that often reap the most benefits. In fact, small and mid-cap listed companies typically lack the resources for intensive investor relations marketing, making Market Making a valuable ally in promoting liquidity. Conversely, large-cap listed companies, with their broader visibility and investor base, have a lesser reliance on Market Making.
Market Makers are like the conductors of the financial orchestra. They help to keep markets liquid, making it easier for transactions to occur and helping to build confidence among investors. Corporations, exchanges, and traders form the ensemble, but it’s the Market Makers who provide the rhythm, ensuring liquidity and stability.
However, this brings us to a critical question:
Should Hong Kong consider allowing equity Market Making?
As we delve deeper into the intricacies of Market Making, it’s worth noting that Pelican’s executives bring a wealth of firsthand experience to the table. With a track record in overseas markets, they have navigated the complex world of Market Making, further enriching the insights shared in this discussion. Bringing the global perspective to the local context could be the key to unlocking Hong Kong’s stock market liquidity potential.
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