Volatility Control Mechanism (VCM)

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What are the design principles behind the VCM model for Hong Kong?

HKEX’s proposed VCM is specifically designed to safeguard market integrity from extreme price volatility arising from automated trading (“Flash Crash”, bad algorithms, etc.). It also serves to alert the market with a temporary cooling-off period for the participants to reassess their strategies and positions and make investment decisions. It is not a trading halt, does not intend to limit the ups and downs of stock prices due to fundamental events, and it also does not work the same way as the daily price limit model which sets a specific daily price range for securities trading as seen in some markets.

Special care has been taken in the VCM design to minimise market interruption. For example, it applies to individual instrument rather than the entire market, it is based on a dynamic rather than a static reference price, the triggering level (±10%, ±15%, or ±20% for securities market depending on the stock group) is set up such that it would not trigger the VCM too often, and the VCM monitoring is not applicable in certain periods (the first 15 minutes of the morning and afternoon CTS and the last 20 minutes of the afternoon CTS [morning CTS on half-day trading day]) and to certain instruments.

How does the VCM model work in the securities market?

HKEX has adopted a dynamic price limit VCM model, which would trigger a cooling-off period in case of abrupt price volatility detected at the instrument level.

The following diagram illustrates the case of a VCM trigger on an applicable instrument, using 10% triggering threshold and price band in the Cooling-off Period as an example.

The VCM is only applicable for board lot order input during the Continuous Trading Session (CTS), but not for any orders input during the Pre-opening Session (POS) and the CAS.
During the CTS, the potential trade price of a VCM security will be continuously checked against a dynamic price limit of ±10%, ±15% and ±20% for Hang Seng Composite LargeCap, MidCap and SmallCap Indexes constituent stocks respectively based upon the reference price which is the last traded price 5 minutes ago.
The VCM is triggered if a stock is ±10%, ±15% and ±20% away (for Hang Seng Composite LargeCap, MidCap and SmallCap Indexes constituent stocks respectively) from the last traded price 5-min ago; A 5-min cooling-off period will start.
Normal trading and VCM monitoring will resume on the VCM-triggered instrument after the cooling-off period.

What instruments are covered under the VCM?

For the securities market, the VCM covers all constituent stocks of Hang Seng Composite LargeCap, MidCap and SmallCap Indexes, SPAC Shares, SPAC Warrants, and eligible Exchange Traded Products (ETPs).

The list of the VCM securities and their triggering thresholds are published on the HKEX website.

Any addition of constituent stocks to the indexes will also be added to the list of VCM securities on the effective date of the addition. Similarly, any deletion of constituent stocks from the indexes will also be removed from the list VCM securities on the effective date of the deletion.

For SPAC Shares and SPAC Warrants, they are added to the list of VCM securities on their listing date.

The Exchange will review the list of ETPs to be included into or removed from the list of VCM securities every quarter and will announce the review result via a circular.

Why does the VCM not apply to all stocks in the securities market?

While a review of international practice shows that volatility controls in major exchanges in US, Europe and Asia usually cover all equities, HKEX is of the view instrument-level volatility control is much less relevant for low liquidity stocks. Expanding VCM coverage beyond Hang Seng Composite Index (HSCI) constituent stocks means that less liquid stocks that may not fully benefit from the functionality of VCM are also covered. A high number of triggers on a daily basis would also be generated for these stocks according to the back test.

What is the applicable period for VCM monitoring?

VCM monitoring is applicable to Continuous Trading Session (CTS), excluding:

the first 15 minutes of the morning and afternoon trading session
the last 20 minutes[1] of the afternoon trading session (or morning CTS on half-day trading day)

[1] Since a cooling-off period will last for 5 minutes, the monitoring will stop 20 minutes before end of the Afternoon Session

Why does the VCM not cover the auction sessions?

For auction sessions, the current ±15% price limits in the POS and the ±5% price limits in CAS serve to mitigate excess price movements that may occur during the auction periods.

Why would trading of the related or linked instruments of a particular security / futures contract be allowed to continue if the security / futures contract has had a VCM trigger and is in a “cooling-off” period? What is the rationale behind that?

As the security / futures contract is still allowed to trade within a band during the cooling-off period, its linked or related instruments should be allowed to trade as well. Consideration was given to whether the linked or related instruments should also trade within a band, but defining a band is not practical since the linked or related instruments are typically leveraged or may have inherently different product characteristics. Halting trading of these linked or related instruments would not be preferred too as it may have a significant impact and amount to excessive market intervention. Based on the market feedback received, many respondents agreed the approach taken is the preferred approach for the launch of VCM in the Hong Kong market, as it is new to the market. HKEX would obtain feedback from the market on this arrangement after its implementation and may review it again when the market is more familiar with it.

Can VCM be triggered on an applicable instrument multiple times in a trading day?

Yes, for each VCM instrument, there is no limitation on the number of VCM triggers in the morning or afternoon Continuous Trading Session.

Does the normal price checking during the CTS apply during after a VCM is triggered?

The 24 spreads rule, the 9 times rules, as well as the existing price warning mechanism would continue to be applicable during the cooling-off period.

Can derivative warrants or CBBCs be traded during the 5-minute cooling-off period after the triggering of the VCM?

Since the affected underlying security or index is not suspended and continues to trade within a specified price limit during the 5-minute cooling off period after the triggering of the VCM, the derivative warrants and CBBCs can still be traded without any price limit.

However, investors should note that where events surrounding VCM causes abnormal trading behavior of the underlying leading to hedging difficulties, the liquidity provision obligations of issuers could be exempted. In this case, there may be a temporary absence of price quotes, a reduction in quote size, or a wider bid-ask spread during the 5-minute cooling-off period.

What will happen to Quote Requests for the warrant and CBBC, on a day when the underlying was subject to a VCM?

The issuer will commit to Quote Request obligations during the day, including during the cooling off period, unless an exemption is obtained for Quote Request.

How will the provision of Active Quotes be affected for a warrant/CBBC when the underlying security is subject to VCM?

Investors should be aware that standards for Active Quotes described in the Industry Principles[1] are intended to apply to normal market conditions. Provision of Active Quotes may be affected where there are abnormal or exceptional market conditions.

Quotes provided by liquidity providers necessarily reflect the liquidity of the underlying securities or indices at any given time. If the liquidity of the underlying is impaired by conditions surrounding a VCM event, or by the VCM itself, the liquidity of the warrant or CBBC may be adversely affected in terms of quote size and spread relative to more normal market conditions.

During the 5-minute cooling off period after triggering of the VCM, where issuers’ hedging ability is materially affected due to the uncertainty in the underlying securities or index, it is possible that the minimum service level for Active Quotes will not be fulfilled, such as no bid-ask quotations, widening of bid-ask spread and reduction in quote size.

Similarly, after the 5-minute cooling off period, liquidity provision may still be affected if issuers continue to experience hedging difficulties. Under such circumstances, Liquidity Providers may not fulfil the minimum service level for Active Quotes as described in the Industry Principles.

However, issuers will use best efforts to meet quote request requirements.

[1] Industry Principles on Liquidity Provision for Listed Structured Products (July 2012) published by the Exchange, available at

(http://www.hkex.com.hk/eng/prod/secprod/dwrc/Documents/principle.pdf).

When the cooling-off period is started or ended for a security, will there be relevant message broadcasted in the trading system?

A message will be broadcasted in OTP-C when the cooling-off period is triggered for the specific securities. Information includes: the start time and end time of cooling-off period, reference price and price limits of the securities during the cooling-off period.

Since the information of cooling-off period’s end time has already been included in the message when cooling-off period is triggered, there will be no additional message broadcasted at the end of cooling-off period.

Would VCM Trigger (23) message be disseminated to indicate the end of the cooling-off period?

For each cooling-off triggered by the VCM, a VCM Trigger (23) message would be disseminated in OTP-C when the cooling-off period begins for specific securities. The message provides, among other related information, both the start time and end time of the cooling-off period. There would be no other messages to indicate the end of the cooling-off period.

Would I be able to retrieve the VCM Trigger (23) message by any means after the cooling-off end time has passed?

In general, the VCM Trigger (23) message is available in Refresh Channel for each cooling off period triggered in a day except when the same security has more than one cooling off period triggered for the day. In this exceptional case, only the VCM Trigger (23) message for the latest cooling-off period would be found in Refresh Channel for that security.

How is the Volatility Control Mechanism (“VCM”) determined for a Dual Counter Security?

If a Dual Counter Security is a VCM security based on the existing eligibility criteria, all of the counters would be subject to the same VCM triggering threshold. However, when VCM is triggered in one counter, it would not automatically trigger the VCM in the other counter.