Time to Close the Floor
12 October 2004
When your editor first started work as a young corporate finance executive in the City of London in Sep-86, one of the first things he did in his lunch break was to pay a visit to a place that would soon lapse into history. A brief walk down the road took him to the floor of the London Stock Exchange.
On 27-Oct-86, a revolution known as "Big Bang" occurred in London, and the market moved from a floor-based face-to-face trading system to an electronic quotation system, at the same time as the abolition of minimum commissions and the removal of the prohibition on firms acting as both "jobbers" (or what the NYSE still calls "specialists") and stockbrokers, amongst several other reforms. The equity trading floor closed shortly afterwards, although a small corner remained for stock options.
In Hong Kong, minimum commissions were finally abolished by Hong Kong Exchanges and Clearing Ltd (HKEx, 0388) on 1-Apr-03, and the trading floor is still there, despite having moved to the Automated Matching System (AMS), with the first stocks being admitted in 1993 and the transition completed in Jan-94. AMS meant that instead of brokers manually matching trades face to face on the floor or over the phone, the trades were input into terminals and matched in a computerised order-driven system in strict price and time priority.
Almost 9 years ago, on 25-Jan-96, after much resistance from brokers who thought it might damage the value of their "seats" on the trading floor, the Stock Exchange began allowing trading through "off-floor" terminals in brokers offices. This marked the beginning of the end for the floor, but it has been a long goodbye. Initially only one off-floor terminal was allowed for each on-floor seat held. By the end of 1996, there were 515 off-floor terminals which already accounted for half of the market turnover.
There were and are still a number of ways to restrict the throughput of a terminal, by limiting the order size, or the maximum number of outstanding orders, or the maximum number of order inputs in a given time. For example, on 31-Jan-94, the maximum order size was increased from 100 to 200 board lots, followed by a rise on 17-Feb-97 to 300 board lots, on 26-May-97 to 400 board lots and on 12-Feb-01 to 600 lots. Meanwhile, on 20-Oct-97 the maximum number of outstanding orders per terminal was increased from 200 to 400.
From 9-Jan-98, brokers were allowed to use a second off-floor terminal. On 23-Oct-00, the first phase of AMS/3 was launched, which allowed multiple terminals to share a single broker code previously occupied by a single input terminal. Using an "Open Gateway", brokers were free to connect their own order input systems, including piping client orders straight from their web sites (subject to any credit approval). For electronic orders, there was no longer a need for manual order entry by the broker. On 12-Feb-01 the maximum number of outstanding orders per broker code was increased from 800 to 2,000. On 23-Feb-01, AMS/3 began allowing electronic orders to be routed through the internet and mobile phones to its Order Routing System.
The floor dries up
As shown in the valuation report of the HKEx listing document dated 22-Jun-00, HKEx has a 21-year lease over the 1st and 2nd floors of One & Two Exchange Square, including the trading hall, visitor gallery and ancillary office spaces.
The lease, from the Government, runs from 1-Nov-84 to 31-Oct-05, at a current monthly rent of $1,040,877.34 or about HK$24.18 per sq ft for the 43,040 sq ft windowless space. The lease is as old as Exchange Square itself, and the Stock Exchange opened for business on 2-Apr-86 following the 4-way merger of the old Hong Kong Stock Exchange, the Far East Exchange, the Kam Ngan Stock Exchange and the Kowloon Stock Exchange.
As a result of the move to off-floor terminals and the subsequent introduction of AMS/3, the proportion of trades conducted on-floor has dwindled, and is now down to around 3% of turnover. Due to automated matching, what that means in practice is that the value of trades in which both the buying and the selling brokers are on the floor is now down to around 0.09%. In the other 99.91% of trades, either the buying or the selling broker, or both, are not on the floor.
Probably the only brokers who work on the floor these days are small brokers or sole traders who are treating it as an office and are trying to keep their costs down. Indeed, rumour has it that when a big listing ceremony is being held, officials have to call up brokers and ask them to run down and put their red jackets on to make the place look busy.
The single terminal on the floor can now be better thought of as the "off-office" terminal rather than the "on-floor" terminal. The other thing that the floor facilitates is unrecorded face-to-face conversations between brokers who may then engage in front-running of client orders, rat-trading or market manipulation without detection.
The way forward
Hong Kong cannot live in the past. Some brokers have called for the hall to be retained, or for a cut down version to accommodate those who are unwilling or unable to invest in their own offices. Webb-site.com does not support this, as it would come at considerable cost and would represent a subsidy to the small brokers from the rest of the market, ultimately paid for through the exchange's fees. The only way to avoid such a subsidy would be to directly charge those brokers who wish to stay the full cost of the new hall, including rent, maintenance and the capital expenditure needed to upgrade the equipment, much of which is now obsolete. Frankly it would be better if groups of them got together and built their own dealing room somewhere else.
A shrunken floor would also make it look like Hong Kong had a shrinking stock market, and would retain the image of red-jacketed brokers running around matching bargains which is inconsistent with the modern electronic matching system we have. We should celebrate that system rather than carry on pretending that we still do things manually in some kind of living museum - if that is what we wanted then we might as well put the blackboards up and get brokers to chalk up prices just like the "good-old-days". That's where the term "board lots" and "main board" came from.
Instead, what we should do is:
- Surrender the Exchange Square property to the Government when the lease expires on 31-Oct-05. The Government, as landlord, can then do whatever they like with it.
- Lease smaller premises to act as a media centre, a place for listing ceremonies and a visitor and education centre to exhibit the long and colourful history of Hong Kong's stock markets. The media centre would allow TV stations to give "live from HKEx" market reports with an appropriate screen-based backdrop. The visitor centre would allow the public, and in particular the young speculators of tomorrow, to become more familiar with our markets.
As for what the Government might do with the property, that is really their problem, but given its high ceilings and column-free structure it might be adaptable into an ice skating rink, bowling alleys, another multiplex cinema, a concert venue or even an electric go-karting circuit. The possibilities are endless, and no doubt if they tender it out, the market will find a solution.
© Webb-site.com, 2004