Cut the Spread!
4 October 2004
Back in Jan-02, Webb-site.com called on the Hong Kong Exchanges and Clearing Ltd (HKEx, 0388) to cut the "spread table" which determines the prices at which bids and offers can be posted in our order-driven market. For example, if a share is priced at $0.51, then under current rules the next price up is $0.52 and the next price down is $0.50. This minimum "spread" of $0.01 equates to 2% of the price. We won't repeat all the arguments in this article, please read the original article if you need convincing that free markets work better when there is a minimum of artificial barriers to trade.
Since that article was published, momentum for change has gathered. Your editor was elected by shareholders to the board of HKEx in Apr-03, and one of his few successes in that capacity has been to help persuade the company to push for greater liberalisation of the spread table. On 6-Aug-04, HKEx announced a market consultation to reduce the spread table in two phases. Click here to download the consultation paper. We need your help - click here to jump to our submission form, or read this article first.
In Phase 1, spreads would be cut only for stocks above $30, of which there are only a dozen or so with primary listings in Hong Kong. There are also 7 NASDAQ stocks such as Starbucks which are quoted here under a misconceived pilot scheme but almost never trade.
In Phase 2, two options are presented. Option "2A" would cut spreads for all stocks above $2, and Option "2B", which we favour, would make cuts for all stocks above $0.25. You can't do anything for stocks below that price, because they already have a spread size of $0.001, which is the smallest increment that the trading system can handle.
The reason Webb-site.com prefers Option 2B is on the grounds of fairness and uniformity. If we went with Option 2A, then the market would be segmented into the more efficiently-priced stocks in a "supermarket" above $2, while the rest would trade in the wider-spread "flea market" below $2. We see no reason to discriminate against investors in companies priced below $2 when providing market facilities.
Even with Option 2B, which adopts a minimum spread of $0.001 below $1, this still leaves us with the problem of stocks which trade below 50 cents where the spreads widen progressively from 0.2% to as much as 10% (when the price is at the system-minimum of $0.01). The only way out of that is for companies to consolidate their shares. The Stock Exchange actually has the power under current Listing Rule 13.64 (formerly in the Listing Agreement) to require companies to do this, but has seldom, if ever, used it.
So here is what the spread table will look like if Option 2B is adopted:
| Prices from $ |
Tick size $ |
Max spread % |
Min spread % |
|---|---|---|---|
| 0.01 | 0.001 | 10.00% | 0.10% |
| 1.00 | 0.002 | 0.20% | 0.10% |
| 2.00 | 0.005 | 0.25% | 0.10% |
| 5.00 | 0.01 | 0.20% | 0.10% |
| 10.00 | 0.02 | 0.20% | 0.10% |
| 20.00 | 0.05 | 0.25% | 0.05% |
| 100.0 | 0.1 | 0.10% | 0.05% |
| 200.0 | 0.2 | 0.10% | 0.04% |
| 500.0 | 0.5 | 0.10% | 0.05% |
| 1000 | 1 | 0.10% | 0.05% |
| 2000 | 2 | 0.10% | 0.04% |
| 5000 to 9,995 |
5 | 0.10% | 0.05% |
There is a rather obvious "1-2-5" pattern in this proposal which makes it much easier to remember than the current table. You may notice that there is a discontinuity (a missing $50 boundary) in the $20-$100 range, after which the maximum spread reduces to 0.10%. This is so that a handful of very large companies with stocks priced above $50 can have narrower spreads. We don't object unless they do, in which case it would be possible to shift the categories above $50 to retain the same percentage range as below $50.
Speak now!
We need your help to get this through. There is bound to be a lot of opposition to reform from vested interests (particularly from brokers who like front-running against their clients or to make a spread by standing in the middle). The review of minimum spreads has only happened once in the last decade, so if we fail to get it right now, you will be dealing in a less efficient market for a long time to come.
Whether you prefer Option 2B or something else (in the words of Hamlet, 2B, or not 2B, that is the question...), please click here to submit your views through our on-line form. The deadline (unless extended) is this Wednesday, 6-Oct-04, so act now!
© Webb-site.com, 2004
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