This March, I was invited to join Futures Industry Association’s International Derivatives Conference in Boca Raton, Florida. The conference has been the flagship event for the global derivatives industry for over 20 years and has been gaining momentum and prominence each year. While I’m sure Boca’s sunshine and beach have contributed to its popularity, the more important driver is the rapidly changing industry landscape brought by new regulations. This urges regulators, exchanges, and participants to think together: what does it mean?
Unsurprisingly, this year’s key theme was the tightening of regulations in the capital market. For those unfamiliar with these regulations, they have been developed in the aftermath of the financial crisis in the West and are aimed at bringing more transparency and oversight to the trading and clearing of financial products. Up until now these products have been largely traded and cleared in the opaque Over-The-Counter (OTC) market. This is further exacerbated by the broker-dealer model in the West, where the regulators and exchanges have little visibility into client accounts within broker-dealers. Therefore, the key focus of the new regulations is on moving the relatively complicated financial products from the OTC market to on-exchange/central clearing houses, and on protecting the interest of investors.
What surprised me in this year’s conference, though, is the emphasis that ALL exchanges put on Asia, in particular China. I was honored to be invited to join a CEO Vision Panel, together with the heads of CME Group, Eurex, ICE, Nasdaq, NYSE Liffe and SGX. Nearly all of our global peers plan to make China a key part of their future and nobody wanted to be left out in this “rush to the East”. It is yet another reminder that Hong Kong is not the only one seeking opportunities in China and Hong Kong is in a very unique position to capture the opportunities as China opens up.
However, when international exchanges and investors rush to China, they are not only facing the “wall” of capital account controls, but also face an entirely different market infrastructure and regulatory landscape. The former is well known; the latter is much less understood. The former also sometimes gives rise to the perception that due to closed capital controls, China’s market structures are backward and under-developed. If that’s the conventional wisdom, people are in for a big surprise.
Unlike its western counterparts, China has developed a completely transparent “see-through” model for trading and clearing – regulators and exchanges have visibility down to the individual investor level, such as how many shares are held and how much margin is paid, all in real time. There are 120 million investor accounts open at six China exchanges connected directly with the custodian banks and clearing houses. There is very little flexibility, if any, for broker-dealers to move funds across client accounts, let alone embezzle funds or engage in other malpractice. This is the result of major market structure reforms undertaken by China in the wake of undesirable market practices a decade or so ago. So today, everything is transparent and clean. If the western market is the murky water filled with catfish and carp, then the China market is close to distilled water.
Has China got it right? Has the West got it wrong?
There is a Chinese saying, "When the water is too clean, there's no fish." The problem in China is that the water is too clean. While investors’ money is safe, there is no incentive for financial institutions to innovate as they have been reduced to mere execution agents. Confidence in the market structure might be high, but confidence in the market generating meaningful returns is low and the regulator becomes the ultimate responsible party for the market, which is clearly unhealthy for the market’s long-term development. So we can’t say that China has got it entirely right.
In western markets regulation was light and the water was muddy. There was a lot of mud and arguably too much innovation. The catfish and carp thrived in it. However, the water eventually got so muddy that the whole market lost sight of what was really going on and the market headed into one of the biggest financial crises of all time. So we can’t say that the West got it right either.
We in Hong Kong are in the middle of this tug of war. It is both a curse and a blessing. On one hand, for Mainland and international markets to access each other, huge efforts and investments need to be made to build the “channel” between these two pools of water; on the other hand, once we build the channel, Hong Kong will become the indisputable gateway where the East meets the West. We are uniquely positioned to participate in this historic development.
Recognising how huge the opportunity is, we want to strengthen our own capabilities to take maximum advantage of it – for ourselves at HKEx and for Hong Kong. Investing in our infrastructure, such as our data centre, lays the foundation. Aligning trading hours was another step towards this goal. Building a solid risk management system is another key aspect – we not only need sound management for today’s risks, we also need to be prepared for the risks that come with the bigger opportunities of tomorrow. Finally, we need to start designing a compatible model for mutual market access which plays to the strengths of each side.
As I heard repeatedly in Boca, the world wants to come to China, and I know China wants just as much to come out to the world. Hong Kong is right at the centre of this momentous trend and our success tomorrow depends on our finding the right solution for both sides today. With Hong Kong people’s entrepreneurship and diligence, I have every confidence that we’ll be able to achieve it.
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