124
BIS Papers No 12
Electronic trading in Hong Kong
and its impact on market functioning
Guorong Jiang, Nancy Tang and Eve Law,1
Hong Kong Monetary Authority
1.
Introduction
The use of electronic trading (ET) platforms has expanded rapidly in recent years, from liquid and
homogeneous instruments on organised exchanges, such as stocks and futures, to a wide variety of
instruments in foreign exchange and fixed income markets, in both wholesale inter-dealer markets and
retail markets. The introduction of ET platforms has the potential to change the way the market
functions. Such platforms increase the operational and informational efficiency of the market through
reductions in transaction costs and improvements in market access and transparency. However,
increased competition could reduce dealers’ incentive to make markets and adversely affect market
depth. The overall effect of ET on market liquidity is an unresolved issue.
This paper examines the recent emergence of ET platforms in Hong Kong, and discusses its likely
impact on financial market functioning, drawing on recent studies by the Committee on the Global
Financial System (CGFS) and others, and results from our empirical work. Based on intraday
transactable, firm quote prices and trade data in the Hong Kong stock index futures market, we find
evidence that ET helps to improve market liquidity by reducing bid-ask spreads (BASs), after
controlling for the effects of price volatility and trading volume. Furthermore, BASs widen under ET
relative to a floor-based trading system when trading volume increases at times of market stress.
However, ET will underperform a floor-based system only under extreme market conditions. As a
result, this study sheds some light on how market liquidity behaves under ET during normal times and
under stress.
The rest of the paper focuses on two topics. Section 2 describes the characteristics of major trading
platforms in Hong Kong in the over-the-counter (OTC) fixed income and foreign exchange markets