Liquidity providers
The Listing Rules require an issuer to appoint a liquidity provider to provide liquidity to every structured products it issues, including derivative warrant (known as “warrant”), CBBC and inline warrant.
How does a liquidity provider work?
A liquidity provider can provide liquidity for structured products by providing quotes, i.e. provision of buy and sell orders for trading. Quote provision can be either active quotes or quote requests.
Active quotes
Liquidity providers may provide liquidity for structured products by actively inputting orders into the Exchange's trading system. However, active quotes may not strictly be "continuous" because liquidity providers may need to pause the provision of active quotes for a reasonably short period of time to adjust quote parameters in response to market conditions or operational needs. In practice, active quotes are usually provided for at least 90% of the time of a trading day for structured products that meet the criteria for active quotes below. Each pause to provide liquidity normally does not exceed 10 minutes.
Active quotes only apply to structured products that satisfy the following criteria (as measured on a real time basis):
- An active underlying (i.e. local indices and stocks listed on the Exchange which are eligible for CBBC issuance, representing stocks with the highest turnover in the market);
- 50% or less of their aggregate number outstanding in the market;
- for warrants and inline warrants, remaining time to expiry of 30 calendar days or more;
- for warrants only, moneyness between 20% in-the-money and 20% out-of-the-money. “Moneyness”, also known as “in-the-money” or “out-of-the-money”, describes where the underlying asset price is in relation to the warrant’s strike price, and is derived by comparing the spot price or level of the underlying asset and the strike price or level. You may check out more details from the Industry Principles on Liquidity Provision for Listed Structured Products (the “Industry Principles”);
- for inline warrants only, from 20% below the lower strike price or level to 20% above the upper strike price or level; and
- for CBBCs only, the prevailing price of the underlying stock falls outside 2% of the call price or the prevailing level of the underlying index falls outside 1% of the call level. This “qualified range” is derived by comparing the spot price or level of the underlying asset and the call price or level.
If you want to know whether a particular structured product is eligible for active quotes, you may contact the liquidity provider.
Quote requests
Liquidity providers provide quotes by responding to requests for quotes, according to the committed service level set out in the relevant listing document. These standards typically include:
- The maximum response time, i.e. the maximum time it will take to submit a pair of quotes after a request is received;
- the maximum spread between the bid and ask price;
- the minimum quote size; and
- situations in which a quote will not be provided.
You can call liquidity providers for a quote. Their phone numbers can be found on the designated page of the structured product, the HKEX website and the listing document.
Who can be a liquidity provider?
A liquidity provider must be an Exchange Participant. Though this is not a requirement, a liquidity provider is generally a member of the issuer’s group of companies. An issuer can appoint different liquidity providers for different structured products it issues. A liquidity provider can serve more than one structured product issued by the same or different issuers. However, each structured product can only have one liquidity provider.
To help distinguish its liquidity providing activities from other agency trading, each liquidity provider is assigned a unique Broker ID 95XX, 96XX or 97XX. A liquidity provider uses the same Broker ID for all structured products it supports.
To ensure market liquidity is not affected should the liquidity provider fail to perform its functions, an issuer may appoint a backup liquidity provider for contingency purposes.
How do liquidity providers fulfil their obligations?
Liquidity providers’ obligations are specified in the respective listing documents and they implement active quote liquidity in accordance with the Industry Principles. However, there are certain circumstances specified in the listing document under which the liquidity provider is not obliged to provide quote upon request. Examples include:
- the structured product or any underlying asset is suspended from trading for any reason;
- when there are operational and technical problems beyond the control of the liquidity provider that hinder the liquidity provider's ability to provide liquidity;
- if there is a "fast market" (i.e. situations where the underlying shares or the stock market experiences exceptional price movement and high volatility over relatively short periods of time) which materially affects the issuer's hedging ability;
- if the theoretical value of the structured product is less than $0.01;
- where the underlying asset is an index, if there occurs or exists any suspension of, or limitation imposed on, trading of options or futures contracts relating to the index or if the index level is not calculated or published as scheduled for any reason; or
- when there is no structured product available for market making activities.
As the obligations of liquidity provider and circumstances under which the liquidity provider is not obliged to provide liquidity may vary for different structured products, it is important to read the listing document carefully.
Also the liquidity provider is not obliged to provide quote during a pre-opening session or a closing auction session (if applicable); and during the first 5 minutes of each morning session or the first 5 minutes after trading commences for the first time on a trading day.
Although liquidity providers are appointed to provide quotes, this does not imply that they must take up all the outstanding orders in the market. Liquidity providers can provide quotes at the price level they deem fair provided they comply with the maximum spread requirement in the listing document. Therefore, there are chances that their quotes cannot match with your expected price levels and leave your orders unexecuted.
Who evaluates the performance of a liquidity provider?
Performance of liquidity providers are evaluated by the Stock Exchange. In case of any non-compliance with the obligations as set out in the listing document, the Stock Exchange will take regulatory actions as appropriate.
Besides, liquidity providers are required to comply with the relevant securities regulations.
However, don't be mistaken about the role of liquidity providers. Liquidity providers are not required to support prices of structured products. They provide quotes after considering the supply and demand situation at the time. You should refer to the respective listing documents for the obligations of liquidity providers.
As an investor, before you buy a structured product, it is in your best interest to check out the performance of a liquidity provider. For instance, find out whether it always provides quotes with narrow spreads; how quickly it responds to quote requests and when it acts as the liquidity provider for another structured product, whether its level of service is consistent over the life of that structured product.
To understand more about structured products listed in Hong Kong, please refer to the frequently asked questions (FAQ) posted on individual issuers' websites or the HKEX website.
22 January 2021