No More Delays

How ironic that in a week in which Hong Kong was again named the World's freest economy, the Government was again talking about delaying the abolition of minimum commissions to protect the inefficient small broker cartel. So much for letting the market pick winners. If the Government believes in free markets, it must allow brokers and clients to negotiate their rates.

Commission Deregulation: No More Delays
13th November 2002

Yesterday the right-wing US think tank, the Heritage Foundation, again labelled Hong Kong the World's Freest Economy - a huge irony for an economy which lacks any competition law to restrain anti-competitive prices.

One perfect example surfaced again this week, when stockbrokers were seen lobbying the Government and the Securities and Futures Commission to further delay the abolition of minimum commission rates, now due to be scrapped on 1-Apr-03. The minimum commission rate is set by the Stock Exchange of Hong Kong Ltd (SEHK), which has a legally-protected monopoly on the operation of a stock exchange in Hong Kong and is owned by Hong Kong Exchanges and Clearing Ltd (HKEx). Rule 534 sets the minimum at 0.25%.

Deregulation was first announced by HKEx on 17-May-00, giving almost 2 years' notice that the rule would be scrapped with effect from 1-Apr-02. In that announcement, HKEx Chairman Charles Lee Yeh-kwong (Mr Lee), who was also a member of the Government's Executive Council, said:

The Government, which despite owning no shares in HKEx, appoints a majority of its board, issued a press release on the same day hailing the move, stating:

In January this year, caving in to pressure from small brokers who threatend to march their employees through Central ahead of the Hong Kong Chief Executive's re-selection, the Government sheepishly delayed the move for a year, leaving it to brokers to relay the news to the press. Finally the HKEx board issued an announcement on 20-Feb-02, stating:

So there you have it - the HKEx has already announced the rule change - all they have to do is put it in the rule book, and get the SFC to approve it. What is HKEx waiting for? Directions from government, of course. Mr Lee was quoted in this morning's Standard:

Mr Lee, you don't need a "proposal to change the minimum brokerage fees" - your board has already resolved to scrap them - or have you forgotten? Of course, Mr Lee has ignored what the HKEx board announced in Feb-02, and has tacitly admitted that it is the Government that calls the shots, not the HKEx board.

Meanwhile Secretary for Financial Services and the Treasury Fred Ma Si-hang, who is fast earning the title of "Mr U-Turn", stated as recently as July this year that it was not possible to continue the minimum commission policy "as protection for brokers", but on 8-Nov-02 he said:

Capitalism with HK Characteristics

Deng Xiao-ping must be laughing in the great politburo in the sky. Having spent the twilight of his life trying to ease the PRC out of central planning and into the market economy, if he were around today, he would see a Hong Kong government indulging in protectionism, intervention and central planning. The mainland markets, incidentally, have already deregulated brokerage rates on 1-May-02.

It is entirely true that Hong Kong has too many brokers, and that over 400 of them handle less than 20% of the market volume. If forced to compete, many would simply close down, having failed to merge or invest in new technology for competition. All they are doing now is dragging their feet, collecting a little more profit before they close. They were paid off handsomely when the HKEx was formed, receiving millions of dollars worth of shares in HKEx, and have now had 3 years to prepare for competition.

Periodically, one of them collapses, and often the proprietor disappears taking tens or hundreds of millions of dollars of client assets with him. That's the problem with small brokers - the owner is basically his own compliance officer, and you depend on him to segregate his assets from yours, which he often finds hard to do when the bailiffs are knocking on the door. Apart from orderly closures, there are already 3 broker collapses involving alleged fraud this year, including one which ironically was announced on 24-Jan-02, the day after deregulation was delayed.

The costs to the community of the brokerage cartel go beyond the excess commissions and broker defaults. The SFC would need fewer resources to supervise 50 brokers than 500, allowing them to spend their finite income on other enforcement areas such as prosecuting those who abuse minority shareholders. Hopefully, the removal of sole proprietor or mom-and-pop brokerages and concentration on the regulation of larger brokers with better compliance systems would result in fewer thefts of client assets when a broker closes down.

The Government must cease acting in the interests of a small sector of the economy and start acting in the public interest. For sure, brokers will lose jobs, but that is what makes a free market efficient. The moment the government starts setting prices in any sector to protect jobs, we are on the path to central planning, and China has shown since 1949 that does not work.

The HKEx's commercial position

Let's compare two conflicting beliefs attributed to the board of HKEx. In response to a question in the Legislative Council on 14-Nov-01, the Government stated:

Now if the free negotiation of commission will stimulate trading, then that also increases the HKEx's trading fee income (0.005% on each side of a trade) and the settlement fee income (0.002% on each side), and hence increases its profitability, since its variable costs are nearly zero (a few more units of electricity for the computers, perhaps). However, contradicting this statement, on 20-Feb-02, the Board said:

Of course, the first statement was right, and the second wrong. Basic economic theory will tell you that when transaction costs decline, the propensity to transact will increase. Arbitrageurs eking out small profits from trading will find more profitable opportunities to trade if fees are lower, and investors will switch positions more often.

So it should be clear to any independent director of HKEx that deregulated commissions will increase profitability of HKEx. However, as we said, a majority of its directors are appointed by the Government, not by shareholders.

Wide spread tables reduce volume

While we are on the subject of the profitability of the HKEx, let's note that it has failed to make any changes to its ridiculously wide spread table, which also inhibits transactions, but helps brokers to profit from trading the spread. Indeed, in the Oct-02 issue of HKEx's magazine, Exchange, CEO Kwong Ki-chi inadvertently supports our argument, stating:

That implies that the gap between the best bid and offer is being restrained by an artificially wide spread table which determines the minimum increment in prices. If you narrow that table, then the spread will come down, and volumes will increase.

So let's not hear any complaints about declining revenues and volumes at HKEx or SFC (which receives a transaction levy) until they sort that one out.

Break the cartel

HK is one of the last remaining markets with minimum commissions, and it is time to bring this to an end. Further delay would further reduce the credibility of the Government's goal to make Hong Kong a world-class market, or even a regional centre. As for those brokers who say "let's wait until the market picks up" - forget it - we never saw them volunteering to deregulate during the last bull run. They have a choice: compete or close. It's a free market, isn't it?

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Commission Deregulation: No More Delays 13th November 2002

Capitalism with HK Characteristics

The HKEx's commercial position

Wide spread tables reduce volume

Break the cartel

Commission Deregulation: No More Delays
13th November 2002