THỊ TRƯỜNG CHỨNG KHOÁN HỒNG KÔNG (HKEX ) (TIẾNG ANH)

Mini-HSI Options: An Additional Investment and Trading Tool at Third Party Clearing to be Introduced in the Securities Market 17 Proposals Sought for Single Trading Screen for Equity and

October 2002

David Cheung discusses HKEx’s Treasury

operations and investment

Study of Listing Costs

The Quality

of the

30

Mini-HSI Options: An Additional Investment and Trading Tool at

Third Party Clearing to be Introduced in the Securities Market 17

Proposals Sought for Single Trading Screen for Equity and Derivatives Products 21

Chatroom with Chief Financial Officer & Treasurer David Cheung 22

Status Report on New Product and Market Development Initiatives 44

Hong Kong Exchanges and Clearing Limited 12/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong Tel: (852) 2522 1122 Fax: (852) 2295 3106

I am pleased to introduce the sixth

issue of the “The Exchange”

This issue features an analysis of

the quality of the Hong Kong

market where its key elements –

issuers, investors, intermediaries,

infrastructure and information

– are discussed from the viewpoint

of quality Maintaining a quality

market reinforces our status as an

international financial centre

There is also an overview of the Hang Seng Index Option contractwhich we will introduce in mid-November The new contract willcomplement our Mini-Hang SengIndex Futures contract and provideadditional investment opportunitiesfor individual investors

Mini-In the Chat Room, Chief FinancialOfficer & Treasurer, David Cheung,explains his role and discusses HKEx’s

Treasury operations and investmentpolicy

Elsewhere, there is discussion of ourplans to introduce Third PartyClearing in the securities market, andupdates on the implementation of ournew CCASS/3 and DCASS clearingsystems The CCASS/3 and DCASS

p r o j e c t s d e m o n s t r a t e o u rcommitment to investing in ourmarket infrastructure

Another article briefs readers on thelatest status of the development of asingle trading screen for all products

t r a d e d o n o u r s e c u r i t i e s a n dderivatives markets In addition, there

is an update on our extended tradinghours proposal

Research & Policy of the CorporateStrategy Unit has contributed a study

of listing costs in several major stockmarkets which shows that the listingfee remains a very small component

of total listing costs

We welcome your opinions andsuggestions as we believe that

t h e y h e l p u s t o m a k e f u r t h e rimprovements We look forward

to hearing from you

By Kwong Ki-chi, Chief Executive, HKEx

Quality is the stated goal of many exchanges The quality of a marketplace depends on trade-offs among the objectives of the various players The regulators and the market operator can help optimise such trade-offs The Hong Kong market enjoys a good reputation for quality in many respects, and Hong Kong Exchanges and Clearing Ltd (HKEx) is working on areas that need further improvement.

Introduction

Recent events, such as the US corporate scandals and, in Hong Kong, the penny stocks incident, have focused publicattention on market quality Some commentators agreed that penny stocks should be delisted to improve marketquality; others felt that this was none of the regulator’s concern In the course of the debate, commentators comparedHong Kong’s standards with those of overseas markets, including the Mainland of China The rising standards of theMainland market make quality a particularly pressing issue for Hong Kong

This article discusses the idea of quality of the Hong Kong market more broadly The key elements of the market –issuers, investors, intermediaries, infrastructure (both hard and soft) and information – are discussed from the viewpoint

of quality This article is the first of a number of pieces to be published in the Exchange and other forums over thecoming months in which HKEx will examine market quality from various angles

The concept of market quality

Those responsible for the design and operation of securities markets – from government policy makers to marketregulators and exchange managements – are driven primarily by the notion of quality: the desire to make the marketbetter National policy makers want their markets to perform the functions of capital formation (primary market) andtrading (secondary market) effectively and efficiently: they want their markets to be liquid These objectives point in thedirection of making markets as free as

possible However, the financial markets

thus created must remain stable and

systemic risks must be minimised And

issuance of securities by listed corporations

and the conduct of business by the

intermediaries must be fair to investors

These objectives require the imposition of

restrictions, such as requirements for issuer

track records and governance processes,

intermediary qualifications and capital So

market designers face a dilemma

The solution is to optimise the objectives in such a manner that the restrictions reinforce quality and the perceptions

thereof, and so build confidence and stimulate more activity This is, in effect, a quality strategy Generally, market

designers have followed this quality strategy over time Over the past two decades, in virtually all world markets, therehas been deregulation – in the sense of greater freedom to do transactions in both the primary and secondary markets– and at the same time a greater compliance burden for players in exercising that freedom – in the sense of mandatorydisclosures, procedures and capital requirements So far, this quality strategy appears to have been broadly successful, inthat volumes of securities issuance and trading have increased dramatically over time during that period For example,stock trading by members of the World Federation of Exchanges has increased from US$911 billion in 1981 to US$40,093billion in 2001, an average annual growth rate of 21 per cent But with deregulation may come excesses and abuses and

it is not uncommon to see market reforms being tempered by the tightening of rules and regulations Currently,following the US corporate scandals, the world appears to be in the middle of another phase of compliance tightening,

as regulators everywhere issue new corporate governance rules

There has been extensive management literature on quality in business generally, for example, Total Quality Management(TQM), and the standards set by the International Standards Organisation (ISO) Some exchanges, such as the TaiwanStock Exchange, have obtained ISO certification (ISO 9001 and 9002) However, there has been limited discussion ofquality as applied specifically to securities markets

Guidance specific to exchanges has been issued by various market associations The International Organisation ofSecurities Commissions (IOSCO) has issued principles, in respect of which for example Hong Kong’s Securities andFutures Commission (SFC) reports annually on compliance The World Federation of Exchanges has issued the GenerallyAccepted Principles of Securities Trading, and also studies of best practice in areas such as clearing and settlement In

2001, the US National Futures Association and Futures Industry Institute issued best practice recommendations

A few exchanges have functions devoted explicitly to market quality Examples are the London Stock Exchange, whichformerly had a Quality of Markets department, and the New York Stock Exchange which publishes a monthly MarketQuality Report In these exchanges, the intermediaries (specialists or market makers) play a discretionary role and it isimportant to measure their performance, for example in terms of the bid-ask spread However, in the Hong Kong stockmarket, the bid-ask spread is largely a function of the spread table, i.e the price increment, so such measures as the bid-ask spread are less relevant

An agreed and comprehensive model of market quality relevant tothe Hong Kong market is largely lacking Accordingly, a simple model

is suggested below The various elements of the market may be viewed

as in the following chart under a “Five-I” structure – Issuers,Intermediaries, Investors, Information and Infrastructure Theseelements are interlinked and reinforce one another, such linkage beingrepresented by the image of the circle – a “circle of quality” – whichconstitutes the market place as a whole The individual elements, theFive I’s, are discussed in turn in the following section

5 October 2 0 0 2

The Market Quality Circle

Regulator

Market Operator

Market participants Marketplace

The market network through which market operators and regulators interact with other elements

Market place Issuers

Information

Infrastructure (software)–

Rules & Policy framework

Infrastructure (Hardware)–

Systems &

technology

It is necessary to measure the quality of these various elements, e.g in order to identify where improvements may beneeded Some quantitative attributes such as liquidity can be measured directly However, value attributes such asfairness and integrity are more subjective HKEx conducts periodic surveys of market user groups such as fund managers,retail investors and issuers to assess their views on the quality of the markets it provides

of the economy Market designers must try to meet these various objectives

Commercial performance presents market designers with a particularly thorny issue Formerly, many regulators wouldform a view on the commercial prospects of the issuer, and approve, or disapprove, the listing and the pricing of thelisting on that basis – the so-called “merit-based regulation” One problem with merit-based regulation is that regulatorsare not necessarily good judges of commercial potential Another problem is that such exercise of discretion can invitecorruption Thus most market regulators now approve listings in accordance with a more objective, disclosure-basedphilosophy Some merit elements remain, such as the initial listing requirement for a profit track record, but they arecodified in rules and where possible quantified

The imposition of these entry requirements means that smaller, riskier and newer enterprises tend to be shut out of themarket This would appear to conflict with the disclosure-based philosophy as it could be argued that, on a fullydisclosure-based approach, even smaller and riskier issuers should be allowed to list provided that they make properdisclosure of their risks Many exchanges have dealt with this dilemma by creating a second board, such as HongKong’s Growth Enterprise Market (GEM), for such companies Because they are listed on the second board, investorsshould be alerted to their higher commercial risk.

However, issuer quality is not a one-off question at the point of listing If the commercial performance of an issuerdeclines after listing, this has an impact on its shareholders and in aggregate terms on the market Should low-performingissuers be delisted? There is again a policy dilemma If the stock is delisted, on the one hand, there is an assurance thatall stocks listed on the market meet a certain quality standard and this may raise investor and issuer confidence in themarket overall However, on the other hand, existing shareholders in the company will lose the ability to trade out oftheir holdings and the issuer will also lose the intrinsic value of its listing (realisable for example through shell reactivation).The policy maker has to weigh these conflicting factors

Hong Kong has up to now had a rather minimalist approach under which issuers are delisted only in extreme cases andafter a considerable period Some overseas markets impose strict requirements for continued listing, and failure tomeet them can result in the issuer being delisted promptly Nasdaq, for example, delisted 815 issuers in 2001; HKExdelisted 11

Sourcing a variety of issuers for a market is a commercial matter for the exchange concerned

The exchange can attract new kinds of issuers by developing an alternative board, and by targeted

marketing and branding Nasdaq, for example, has been successful in attracting technology

companies from all over the world HKEx has been marketing its Main Board and GEM to

Mainland companies, including private enterprises and technology companies, with much success

The foregoing discussion applies to equity issuers For derivatives there are fewer quality

considerations relating to the product All HSI futures contracts are identical, and the contract

design largely follows international practice The more important quality issues for the derivatives

market relate to risk management and systems – discussed below under Infrastructure

Going forward, HKEx will seek to address these issues through changes to the Listing Rules Regarding issuers’commercial performance, HKEx will be reviewing the requirements for initial listing to ensure that these remainappropriate Fresh proposals for continued listing and possible delisting of low-performing issuers will also be publishedfor market comment There is room for improvement in the effectiveness of issuer regulation: a recent HKEx surveyshows that fund managers are only marginally satisfied with it1 Accordingly, following the consultation on corporategovernance that was completed earlier this year, HKEx will be introducing enhancements to the corporate governancerequirements of the Listing Rules on a phased basis A subsequent article will explain HKEx’s corporate governanceinitiatives in greater depth

mix of investors with different views, so that they trade against each other, resulting in constant liquidity The HongKong market has traditionally been relatively fortunate in this respect Over the past ten years, some 45 per cent ofstock market turnover has come from local retail investors, 29 per cent from overseas investors, 22 per cent from localinstitutions, and 4 per cent from principal trading2.

The sophistication of investors also contributes to market quality Where investors trade speculatively, on rumour,security prices are likely to be highly volatile, and price formation will not relate to fundamentals Such characteristicsmay deter some investors from participating at all Although difficult to measure objectively, investor sophistication isimportant for the market In a recent HKEx survey, listed companies considered the investor base of the Hong Kongmarket moderately attractive3

Investor protection and education are means to encourage investors to participate in the market; HKEx is working inconjunction with the SFC and the Government to promote both The new Securities and Futures Ordinance (SFO)will strengthen the power of the SFC to regulate market manipulation and insider dealing; it will also bring certainsecurities activities previously conducted by exempt dealers within the ambit of regulation These measures will improveinvestor protection Amendments are also being made to the Companies Ordiance to enable investors to enforce theirrights against issuers A subsequent article will deal with investor protection in greater detail

Intermediaries

The main intermediaries in the secondary market are brokers, although banks play an increasingly important role inserving stock investors4 Investors want their brokers to behave honestly, safeguard their customer’s interests, be sufficientlywell-capitalised for their level of business activity, execute trades efficiently and give good professional advice – all at areasonable price Most investors in Hong Kong appeared satisfied with the services provided by their brokers5

In the primary market, investors rely on intermediaries in a broader sense – investment banks and lawyers who preparethe issuer for listing, and accountants who report on the truth and fairness of the company’s financial statements In theListing Rules, there are specific requirements relating to the duties of sponsors For example, sponsors are required toensure that the applicant company is suitable for listing, that the directors are aware of and can be expected to honourtheir duties and obligations, and that all material statements in the listing document have been verified and complywith the rules These requirements complement the Code of Conduct for Financial Advisers recently introduced by theSFC The issuers who engage these intermediaries, and the investors who rely upon their work, expect them to observe

a high standard of professionalism Surveys indicate considerable satisfaction with the services of primary marketprofessionals6

Looking forward, the SFO will bring in a unified licensing regime for securities and futures practitioners, includingcorporate finance practitioners This regime will enable some firms to streamline their capital requirements and operatingstructures, so saving costs HKEx will work with the SFC to streamline filing procedures for participants For newindividual entrants to the industry, the licensing regime requires the passing of exams; the Hong Kong SecuritiesInstitute acts as examiner and also provides continuing professional education HKEx will also work with the SFC on

2 HKEx Cash Market Transaction Survey 2001.

3 41% of issuers considered the investor base attractive; 26% considered it unattractive.

4 49% of retail investors use banks only (HKEx Retail Investor Survey 2001).

5 80% of investors were satisfied with their broker’s stock trading services; 4% were dissatisfied (HKEx Retail Investor Survey 2001).

6 41% of respondents to an HKEx survey found the professional conduct of sponsors good; 21% found it poor For lawyers the corresponding figures were 65% good and 6% poor; for accountants 63% good and 8% poor.

improving the professionalism of financial advisers under the latter’s Code of Conduct Over time, these measuresshould help raise standards in the industry.

Infrastructure – systems and technology

The “hardware” of the market is important to its quality Brokers are the main direct

users of market systems They require systems to be reliable, but also user-friendly,

low cost and efficient They also require special functionalities to support their

operations, for example, quote maintenance mechanisms for market making

Unfortunately, these objectives may conflict Very high levels of reliability require

intensive engineering and back up facilities – all of which are expensive and must

ultimately be paid for by the user This is not such an issue when transaction volumes

are high; but with the current low volumes, at least on the stock market, system cost

becomes a significant issue

HKEx has made extensive investments in new infrastructure over the past couple of years On the stock side, a newtrading system – AMS/3 – has been rolled out, and the clearing system is being upgraded in stages to CCASS/3 On thederivatives side, trading has been migrated off the former Futures Exchange floor to the HKATS system, the stockoptions market has been migrated from the former TOPS system to HKATS – so that all HKEx derivatives are trading

on one system Surveillance of the market is conducted through the automated monitoring system SMARTS

Going forward, HKEx will seek to further integrate its systems so as to improve efficiency and productivity for marketusers A new derivatives clearing system DCASS will be introduced next year to bring better integration between theclearing platform with the trading platform HKATS An integrated front end will be developed so that exchangeparticipants can more easily access HKEx systems And HKEx will participate actively in the development of thescripless trading environment and other financial infrastructure initiatives recommended by the Steering Committeefor the Enhancement of Financial Infrastructure

Infrastructure – rules and policy framework

Just as important as the hardware is the market “software” of rules and policies The policy objectives here are tomaintain market integrity and systemic stability, while at the same time allowing as free play of market forces aspossible

Access to the Hong Kong market is relatively unrestricted In contrast with some overseas markets, there are no restrictions

on foreign investment into the market, or on overseas investment by domestic players For intermediaries, access isopen to foreign-owned as well as domestic players To become a participant, a broker has to acquire a trading right.HKEx is currently prohibited from issuing new trading rights at prices lower than HK$3 million for the stock marketand HK$1.5 million for the futures market under the terms of the merger of the former stock and futures exchanges.However, this prohibition will end in March 2004

The risk management process aims to maintain systemic stability Thus, in addition to maintaining minimum levels ofliquid capital proportionate to their business volumes, brokers are required to provide margin for their derivativespositions, and to deposit more margin if the value of their positions changes adversely

HKEx is in the process of reviewing its rules and the overall policy framework to see where improvements can be made

to facilitate trading without unduly increasing risk For example, a new regime for the issue and listing of derivativewarrants was implemented in early 2002 which has led to increased issue and trading of such instruments Also,relaxations to the regimes governing short selling and derivatives trading are being examined in conjunction with theSFC A more comprehensive review of the derivatives market trading environment will be made in the coming year.HKEx is also working with the SFC and the Government in the review of the public offering mechanism Somesimplification and streamlining to the procedures in the Companies Ordinance is to be introduced to provide relief inthe nearer term, while at the same time work is beginning on a fundamental review of the public offering provisions ofthe ordinance

Transparency also applies to the market operator and the regulators They need to make their policy decisions anddevelopment plans clear, so that market users can follow accordingly And regulatory judgements have to be seen to befair, with a clear avenue for appeal

HKEx is working on changes to the Listing Rules to implement the improvements in corporate disclosure that itproposed in a consultation earlier this year A subsequent article will give further details on this In the derivativesmarket, more information will be shown on market depth to facilitate trading HKEx has already introduced an alternativequotation-based charging mechanism to facilitate trading by investors who do not require the full information service

Regulator and market operator

The above section describes the elements of the market in which quality manifests itself However, the players in themarket – the issuers, investors and intermediaries – are not themselves motivated to contribute to market quality unlessthat is seen to be to their benefit The development of a quality market depends on the efforts of the market operatorand regulator to design, operate and enforce market standards Their efforts will, ideally, create a virtuous circle ofquality in the market place

To achieve this, HKEx works closely with the statutory regulator – the SFC – and the Government under the tiered regulatory structure” to develop market policies, systems and products that meet broader market needs andfacilitate the achievement by the various market players of their objectives This is done in consultation with marketplayers However, it is not an easy task because the objectives of the different players may conflict – for example issuerswould like to achieve higher prices for their stock, and subscribing investors would like to pay less Nor is it necessarily

“three-a m“three-atter of striking “three-a b“three-al“three-ance between the two R“three-ather, the ide“three-al is to optimise the fulfilment of objectives for “three-all pl“three-ayers,

so that issuers, intermediaries and investors have the opportunity to prosper together Good market design creates win scenarios for all the players.

win-In addition to market design, HKEx has a major responsibility for the operation of the secondary market, ensuring thatthe core infrastructure functions efficiently and reliably Considerable press attention has been directed to systemoutages that have occurred in the past year Ideally, these incidents would have been avoided While they had not, it isperhaps worth pointing out that, on the whole, these systems have operated with a high degree of reliability During the

12 months to June 2002, HKATS system availability was 99.97 per cent of the total operable time (the system wasdown for 89 minutes out of 257,431 minutes of mission time) The availability for CCASS was 99.99 per cent and thatfor AMS/3 100.00 per cent That said, HKEx strives to improve system availability even further through thoroughexamination of the root cause of any system problem with a view to minimising and avoiding the risk of repeat incidents

in the future

HKEx also bears the core responsibility for risk management A surveillance team watches the market for signs ofabnormal trading and refers any suspected cases to the SFC for possible investigation The SFC has powers to prosecutesuspected cases of insider dealing or market manipulation

HKEx sets and enforces rules for issuers to access the market (the initial listing requirements) and continuing requirements

on disclosure and corporate governance HKEx’s powers are non-statutory; however the SFC – and if necessary theGovernment through, for example, the Commercial Crimes Bureau – have statutory powers to investigate and bringcases to prosecution This is consistent with the division of responsibility under the three-tier regulatory structure

HKEx’s role as the first tier or front-line regulator was reaffirmed by all concerned - the Government, the SFC, theStock Exchange of Hong Kong and the market at large - during the process leading up to the demutualisation andmerger of the former exchanges in 2000 The Merger Ordinance includes specific provisions ensuring checks andbalances on HKEx’s exercise of its regulatory functions; for example, the maintenance of a “Chinese wall” between theregulatory function and the business functions within HKEx, and the oversight by the SFC While experience since themerger shows that there is room for improvement in the operation of the three-tier regulatory structure, there is strongjustification for HKEx’s role as the first tier or front-line regulator (including its responsibility for listing matters) to bemaintained

The Financial Secretary has appointed an Expert Group to review the three-tier regulatory structure HKEx willcooperate fully with the group and assist it in its work

Conclusion

The above discussion attempts to set out a framework for evaluating the quality of the market as a whole Applying theframework to the Hong Kong market highlights areas of high quality, and also areas where improvements are needed.While as market designer and operator, HKEx has a major responsibility for the quality of the market, other regulatorsand the Government have an important part to play And the activities of the issuers, investors, and intermediaries alsocontribute to market quality

The quality of the Hong Kong market is important because quality is the key value proposition that Hong Kong offersthe world, and the Mainland of China in particular The Mainland securities markets have been progressing rapidly andachieved a certain critical mass However, because of China’s current state of development, including its restrictions onforeign participation and currency convertibility, Hong Kong still has a substantial quality edge7 As China opens itsmarket under the WTO framework and raises its own standards, it will be important for Hong Kong to maintain itsedge The combined efforts of the market community will be needed to achieve this goal

7 57% of issuers, fund managers, and investment banks rated their confidence in the Hong Kong primary stock market as high and 12% rated it as low (HKEx Survey).

HKEx will introduce the Mini-Hang Seng Index (HSI) Option contract

on 18 November 2002 The Mini-HSI Option contract is being introduced

to satisfy the trading and hedging needs of retail investors and in view of

their growing interest in HSI Options and the Mini-HSI Futures contract,

which began trading in October 2000 (see Chart 1 for volume performance)

The new contract will give retail investors additional flexibility, allowing

them to participate on a smaller scale, compared with the existing HSI

Option contract, in the performance of the 33 blue-chip stocks in the

benchmark HSI at a fixed level of risk Mini-HSI Options will also give

retail investors a new instrument for managing their portfolio risk

Chart 1: HSI Options and Mini-HSI Futures Monthly Volume (Contracts)

Oct-00 Nov-00 Dec-00 Jan-01 Feb-01 Mar-01 Apr-01 May-01 Jun-01 Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02 Jul-02 Aug-02

Key product features

The contract multiplier of the Mini-HSI Option contract will be $10, making it one fifth the size of the existing HSIOption contract The contract will have a broad range of strike prices and four different contract months, allowinginvestors to create positions that match their preferred market exposure Table 1 shows the contract specifications forMini-HSI Options

Other key product features of the new contract include the following:

• Mini-HSI Options’ daily settlements and contract expirations will use the same settlement price

as the existing HSI Option contract; and

• The two contracts will be fungible (i.e positions in the two contracts can be offset) at the ratio of

one HSI Option contract against five Mini-HSI Option contracts of the corresponding series

Together, these arrangements will allow the Mini-HSI Option contract to benefit from the liquidity of the larger HSIOption contract

In addition, a margin offset of 100 per cent will be applicable to the product group containing the Mini-HSI Optionand HSI Option contracts, with the delta/spread between the Mini-HSI and HSI Option contracts of the correspondingseries set at a ratio of five to one

Usage of Mini-HSI Options

Buying Mini-HSI Options with limited risk

Unlike futures, where an investor is absolutely committed to a long or short position until closing his position, HSI Options will give the buyer the right, but not obligation, to participate in the price performance of the HSI at apredetermined price Buying a call option will give an investor the right to benefit from a rising HSI, while a putpurchase will allow him to benefit from a falling HSI

Mini-Selling options for premium

Selling options, on the other hand, creates a potential obligation in exchange for the option premium The risk andreward profile in this case is different from buying options Of course, it is always possible to liquidate one’s optionposition by buying or selling an offsetting option before expiration

Advantages of trading Mini-HSI Options

There will be many advantages of trading Mini-HSI Options, including the following:

• Participate in the performance of the Hong Kong stock market as a whole by using Mini-HSIOptions with limited risk as an inexpensive alternative to stock ownership;

• Hedge portfolios smaller than the contract value of the standard HSI Futures contract Also, inconjunction with the standard HSI Futures and Option contracts, investors will be able to useMini-HSI Options to fine-tune hedging activities;

• Protect portfolio value against adverse price moves; and

• Profit from a volatile market regardless of its direction A retail investor will be able to use HSI Options to create an option position that combines the buying of calls and puts This positionwill become profitable as soon as the HSI moves sufficiently, either up or down

Mini-The introduction of the Mini-HSI Option contract will provide retail investors with an additional investment andtrading tool to participate in the upside and downside movement of the HSI at a fixed level of risk and on a smallerscale compared with the existing HSI Options Investors will also be able to use Mini-HSI Options to limit losses andprotect profits, positions and portfolios.

Market education

To familiarise the market with Mini-HSI Options, HKEx is arranging an education programme, including seminarsfor investors and briefings for brokers and their professional associations Exchange Participants can gain a thoroughunderstanding of Mini-HSI Options by completing the Continuous Professional Training Course on the subjectorganised by HKEx HKEx has been publishing educational articles introducing the features of Mini-HSI Optionsalong with common trading strategies In addition, frequently asked questions about Mini-HSI Options and otherinformation on the new product such as the contract specifications are available on HKEx’s website for investors’ easyreference Materials for independent study on Mini-HSI Options will also be available on HKEx’s website soon

Continuous Professional Training (CPT) Courses on Mini-HSI Options

■ Practical applications of Mini-HSI Options

■ Key product features (including position and margin offset)

■ Liquidity arrangement

■ Trading tips on Mini-HSI Options

■ Market information on Mini-HSI Options

For details of the CPT Courses, please call 2526 5190

Investor Seminars

Tickets for investor seminars are available for sale at URBTIX outlets For enquiries, please call 2734 9009

Table 1: Contract Specifications for Mini-HSI Options

calendar quarter months

2:30 p.m – 4:15 p.m (Hong Kong time)

2:30 p.m – 4:00 p.m (Hong Kong time)

of the Contract Month

interval during the Expiry Day

(per contract per side)

To cope with future market demand

and increase the competitiveness of

the Hong Kong securities market,

CCASS/3, the next generation of the

Central Clearing and Settlement

System (CCASS), will bring major

infrastructure upgrades to the system

and new features to current CCASS

functions After the new technical

infrastructure was successfully

introduced in CCASS/3 Stage 1 in

May of this year, HKEx began

preparing for the CCASS/3 Stage 2

rollout of the new functional

architecture The Stage 2 rollout is

expected to be completed by year-end

The functional architecture upgrade

includes the introduction of

multiple-market capability with different

settlement cycles and the ability to

provide extended operating hours

Apart from the architecture upgrade,

new functionalities will also be

introduced to further facilitate

CCASS Par ticipants’ business

operations They include new security

management functions and a

Common Collateral Management

System (CCMS)

Following the implementation of

C C A S S / 3 S t a g e 2 , C C A S S

Participants will be able to maintain

user access rights for authorised

CCASS users directly in CCASS Each

CCASS Participant will appoint at

least two Delegated Administrators to

maintain and monitor the accessrights Hong Kong Securities ClearingCompany Limited, a wholly-ownedsubsidiary of HKEx, will manage theadministration rights of the DelegatedAdministrators based on writteninstructions from the CCASSParticipants

For CCMS, the new system isequipped with the processingcapability for a much wider range ofcollateral types and allows for differentcollateralisation methods thancurrently provided by CCASS Infuture, CCMS will also be able to

p r ov i d e f l e x i b i l i t y f o r f i r m sparticipating in both the securities andderivatives markets to manage theiroverall collateral requirements inmeeting their obligations with HKEx

The securities component of CCMSwill be rolled out as part of CCASS/3Stage 2, while the derivativescomponent will be separatelyimplemented as part of the DCASS(Derivatives Clearing and SettlementSystem) project

As part of HKEx’s project riskmanagement measures, detailedcontingency procedures are beingfinalised for the unlikely event of amajor CCASS/3 Stage 2 system failureduring the initial stabilisation periodfollowing implementation In such acase, the CCASS/3 Stage 1 systemwould need to be restored

To ensure CCASS Participants havesufficient time to make the necessaryarrangements for the contingency

procedures, a paper titled CCASS/3

Stage 2 Rollout Contingency Plan was

distributed to them on 25 July Inaddition, HKEx has been collectingcomments from CCASS Participantsand meeting with major industryassociations and practitioners sinceAugust Constructive comments havebeen received and they are being

i n c o r p o r a t e d i n t o t h e f i n a lcontingency procedures

To ensure smooth implementation,HKEx has organised a series ofpractice and training sessions forCCASS Participants on CCASS/3Stage 2 A number of market rehearsaltests have also been arranged to ensurethe proper functioning of the system

in a production-like operatingenvironment The first two rounds ofmarket rehearsal tests were conducted

on 7 July and 18 August Although anumber of participants were not able

to complete their testing during theAugust rehearsal because of technicaldifficulties, there were no majorincidents involving the new functions

to be rolled out HKEx has taken steps

to resolve technical issues associatedwith the testing environment to pavethe way for smooth runs by allparticipants in the subsequent marketrehearsal tests

HKEx is developing a new derivatives

clearing infrastructure to replace the

current systems operated by the

HKFE Clearing Corporation Limited

(HKCC) and The SEHK Options

Clearing House Limited (SEOCH),

which are both wholly-owned

members of the HKEx Group The

new Derivatives Clearing and

Settlement System (DCASS),

comprising the core derivatives

clearing and settlement functionality

and the margining engine, will be

linked with the Common Collateral

Management System (CCMS)

DCASS will provide a significant

improvement in clearing functionality

for HKCC and SEOCH Participants

and the clearing houses A major

feature of DCASS is online access for

transaction input and data retrieval,

through the DCASS Workstation and

Participant developed applications

that will be connected to DCASS

through the Application Programme

Interface

The DCASS application will run on

the HKATS (Hong Kong Futures

Automated Trading System) host

machine and share its network

infrastructure DCASS also provides

the core functionality related to trade

registration, position management

a n d m a r g i n i n g T h e C C M Sapplication will provide the collateral

m a n a g e m e n t a n d p a y m e n t sfunctionality between clearing housesand Participants CCMS has beendesigned to accommodate the

requirements of both the securitiesand derivatives markets

HKEx believes the combination of anopen and flexible system with the highperformance and capacity of DCASSwill enable the derivatives market tofunction more efficiently and provide

a platform for future marketdevelopment

The DCASS project has nowprogressed to the specification anddevelopment of the reporting and dataaccess functions, which will meet thecombined requirements of the two

derivatives clearing houses and willleverage on the DCASS technicalinfrastructure

Recently, HKEx reviewed the

r e p o r t i n g a n d d a t a a c c e s s

requirements of Participants and theclearing houses to identify thenecessary functionality in DCASS Ageneral briefing and consultation withPar ticipants was held in lateSeptember to ensure the proposedreporting and data access functionsmeet their requirements

Training will be provided in the fourthquarter for the DCASS Workstation,

C C M S Te r m i n a l a n d m a r g i ncalculation engine To ensure smoothimplementation, both ParticipantReadiness and Market Rehearsal tests will

be held in the first quarter of next year

HKEx is planning to introduce Third Party Clearing to the Hong Kong securities market in 2003 Third Party Clearing

is a concept whereby the clearing process and settlement obligations relating to trades conducted on the Stock Exchangeare transferred from the executing Exchange Participant to a designated third party General Clearing Participant orGCP

Third Party Clearing is a relatively new concept for securities markets, but has been a longstanding feature of derivativesmarkets worldwide

The Third Party Clearing model under consideration provides Exchange Participants with an option to focus on theirsecurities dealing business and outsource the clearing and settlement of the trades executed on the Stock Exchange to adesignated GCP Under this arrangement, the Exchange Participant will be categorised as a Non-Clearing Participant(NCP)

Third Party Clearing will create two new types of CCASS (Central Clearing and Settlement System) Participants,General Clearing Participant (GCP) and Direct Clearing Participant (DCP) Exchange Participants who continue toclear and settle their own trades will be reclassified as DCPs A DCP will have the same rights and obligations as today’sCCASS Broker Participant A DCP can only clear its own trades A GCP will be either a registered dealer (with orwithout an Exchange trading right) under the Securities Ordinance or an authorised institution under the BankingOrdinance A GCP will be able to clear its own trades (if it is also an Exchange Participant) and trades executed by NCPExchange Participants who have designated that GCP to act for them

A NCP will have to appoint a GCP as its designated third party clearer prior to trading Both the NCP and GCP willhave to enter into an agreement to be approved by HKEx before the Third Party Clearing arrangement comes intoeffect The agreement will contain the terms and conditions prescribed by HKEx in addition to any commercial termsthat have been agreed between the two parties

Benefits

The introduction of Third Party Clearing will benefit both Exchange Participants and CCASS Participants

Firstly, Exchange Participants will have more options in formulating their business strategies by being able to choose thetype of relationship with HKEx that meets their business needs and financial strength

Secondly, by giving up its clearing functions to a GCP, an NCP will not be obliged to fulfill the funding requirementsarising from the risk management measures of the Hong Kong Securities Clearing Company Limited, a wholly-ownedsubsidiary of HKEx, such as marks, guarantee fund contribution and collateral An NCP will be able to manage itscapital in a more flexible manner and potentially more efficiently.

Thirdly, the netting efficiency in CCASS is potentially higher when trade settlement is concentrated in fewer ClearingParticipants This may increase the overall settlement efficiency and reduce settlement risk in CCASS

Lastly, there may be settlement cost savings for both GCPs and NCPs For GCPs, the average processing cost of atransaction may be lower as a result of economies of scale GCPs may be able to offer clearing services to NCPs at lowersettlement costs than if the NCPs were to run their own operations This may also reduce the cost of securities transactionsfor investors

Market consultation

In July of this year, HKEx issued a consultation paper to solicit comments from Stock Exchange Participants, CCASSParticipants and market practitioners on Third Party Clearing (a copy of the consultation paper can be downloadedfrom HKEx’s website: www.hkex.com.hk) The consultation period lasted for one month and there were 16 submissions,four from brokers’ associations and 12 from CCASS Participants

The general comments were positive, with many respondents welcoming the Third Party Clearing concept as it wouldprovide a more flexible way for brokers to run their businesses Third Party Clearing was also seen as an importantstrategic move to reinforce Hong Kong’s position as a global financial centre The detailed comments are mainlyfocused on three areas, admission requirements, management of NCP risk exposure and the detailed arrangementsbetween the GCP and NCP Some respondents were keen to know more about how the tangible benefits could berealised, the additional risks to be assumed and the likely cost Several respondents expressed interest in providing ThirdParty Clearing services

Based on the responses to the consultation paper, further study is now underway on

the details of the final working model In the process, HKEx will fine-tune the

proposed admission criteria and risk management framework, taking into

consideration of the comments received The market will be consulted on the

detailed model after it is completed The target date for the introduction of

Third Party Clearing is the first quarter of next year

HKEx issued a consultation paper on the extension of trading hours on 4 September 2001, inviting comments frommarket participants and members of the public on proposals to extend the current trading hours of the securities andderivatives markets A total of 997 responses were received, 364 from participants in the stock and futures exchangesand 633 from other respondents, including institutions and individuals.

Based on the responses received, Exchange Participants generally agreed with the proposed extension of the morningand afternoon sessions However, few Exchange Participants supported the introduction of an evening session Theirmain concerns were market volatility, settlement and risk issues, the financial infrastructure (including the servicesprovided by the banking sector and the clearing houses) and the contribution of the evening session to the total marketturnover

The following is a summary of the responses

Should the current trading hours be extended?

Out of 452 respondents who supported the extension of the current trading hours:

including securities practitioners, investors and members of the public

Risk management issues

Some Exchange Participants anticipated additional operational risks with the extension of the afternoon session, mainly

in the funding of day-end marks in the securities market, the funding of day-end margins in the derivatives market andthe collection of margins from clients after the markets close These risks are primarily associated with the inability toarrange funding for payments and to transfer funds from one bank to another after normal banking hours

In view of the concerns raised, HKEx performed a detailed risk assessment, including but not limited to market risk,operational risk and legal risk, in relation to the extension of the morning and afternoon sessions from the perspective

of Exchange Participants and HKEx The results of the review were reported to HKEx’s Risk Management Committee

Board approval in principle

After taking into account the responses of Exchange Participants, the risks associated with the extension of tradinghours and current market conditions, HKEx’s board of directors approved in principle on 26 July an extension of thetrading hours of the securities and derivatives markets

The proposed new trading hours are as follows:

Securities, Hong Kong stock options and Hong Kong stock futures markets

Morning session 10:00 to 12:30 (no change)

Afternoon session 14:00 to 16:30 (current afternoon session: 14:30 to 16:00)

* Following the current arrangements, there will be no lunch break for the Exchange Traded Funds traded under the pilot programme:

iShares MSCI South Korea Index Fund and iShares MSCI Taiwan Index Fund.

Index derivatives markets excluding Dow Jones Industrial Average (DJIA) Futures

Morning session 9:45 to 12:30 (no change)

Afternoon session 14:00 to 16:45 (current afternoon trading session: 14:30 to 16:15)

DJIA Futures

Morning session 9:00 to 12:30 (no change)

Afternoon session 14:00 to 16:45 (current afternoon trading session: 14:30 to 16:15)

There will be no change in the trading hours for interest rate derivatives and International Stock Futures and Options

Market readiness programme

HKEx will co-ordinate an industry-wide effort to educate Exchange Participants and investors on changes arising fromthe extension of trading hours A series of activities including briefing sessions and seminars will be organised, andmarket rehearsals will be held to ensure the readiness of market participants

Implementation

HKEx is currently discussing the details of the proposal with market participants and will seek the Risk ManagementCommittee’s endorsement of the operating and contingency arrangements for extended hours The implementation ofnew trading hours requires amendments to the exchange rules, which are subject to the approval of the Securities andFutures Commission (SFC) Given the time needed for market preparation, HKEx expects to implement the newtrading hours early next year, subject to the SFC’s approval

After implementation, HKEx will monitor market activities during the extended trading hours and will review the newarrangements in light of the experience gained and the market environment

The Common Frontend Project is aimed at providing a single trading screen to access all of the equity and derivativesproducts offered by HKEx with possible extension to overseas markets for HKEx alliances with other major exchanges.

Trading facilities currently provided by HKEx are designed for single market access only The first/second terminals andmulti-workstation systems supported by AMS/3, the Third Generation Automatic Order Matching and ExecutionSystem, are dedicated for the stock market whereas the Click terminals connected to HKATS, the Hong Kong FuturesAutomated Trading System, are used for the derivatives market only A similar situation occurs with the majority offrontend systems acquired or developed by Exchange Participants Very few broker firms have frontends with thenecessary technical sophistication to achieve multi-market connectivity

The Common Frontend Project is part of HKEx’s continuous effort to further enhance the trading infrastructure andaccess capability of Exchange Participants A task force has been set up to explore the feasibility of satisfying thefollowing objectives:

• Provide a single trading screen for convenient access to all HKEx equity and derivatives

products;

• Achieve cost savings in dealing rooms via a reduction in the number of trading workstations

and desktop spaces resulting from an integrated trading interface;

• Increase the capability of Exchange Participants to execute hedging and arbitrage transactions

among different products and different markets in a speedy and effective manner;

• Provide an open infrastructure for Participant connectivity to other markets in a timely

manner for alliance arrangements with overseas exchanges;

• Reduce broker investment on frontend solutions for access to new markets and new products

through better technology and economies of scale

The task force has invited a number of major local and international system suppliers to submit proposals for thecommon frontend The proposals are now being assessed on the proposed integration approach, functionality of the

solution, technology architecture andcommercial arrangements The aim is todetermine whether there are solutions that cansatisfy our business and technical requirements.HKEx will update Participants on the progress

of the project when a decision is made for theway forward