HKEX Report丨Rising Demand for Block Trading in Mainland and HK
Author: Chief China Economist's Office, Hong Kong Exchanges and Clearing Limited
REPORT SUMMARY
Block trading mechanism of equities is important to minimise price impact and avoid unwanted signalling of large-sized transactions, which is detrimental to best execution by brokers. It provides an efficient way to buy or sell large blocks of shares in a single transaction with more certainty in transaction price and timing than trading on the auction market. Various block trading mechanisms prevail in global markets. These include off-exchange negotiated trades with post-trade reporting to an exchange, separate off-exchange trading platforms or dark pools, or specialised on- exchange block trading mechanism. Despite the differences in block trading mechanisms, there is a growing trend in block trading on major stock exchanges as hinted by the growth in negotiated trades.
The growth of the asset management industry is a primary driver for block trading. For an active
asset manager, the price impact of lit orders of on-exchange large-sized transactions erodes the
active returns. For a passive asset manager, the costs of rebalancing on index stocks can be
significant and much higher than the management fees received. In addition, creation/redemption
of fund units sometimes involve large-sized transactions within a short time frame. Demand also
comes from other trading purposes: mergers and acquisitions, share repurchases as well as
transactions by private equities and major shareholders. The development of equity derivatives
and structured products may increase demand for block trading to enhance efficiency of shares
delivery at settlement. Besides, findings of empirical studies showed that negotiated trades (or the“upstairs market”) effectively provide extra liquidity and reduce price impact, particularly for stocks
with low liquidity in the on-exchange limit-order book.
In the Mainland market, the Shanghai and Shenzhen stock exchanges provide dedicated platforms
for block trading. In contrast to world major markets, block trading of A shares in the Mainland has
been dominated by sell-initiated trades ― mainly the placement of shares by major shareholders
after the lock-up period of their substantial shareholdings, rather than by trades addressing the
demand from asset management business. This may explain why the average transaction size of
negotiated trades in the Mainland has been much larger than those in major stock markets.
Nevertheless, the situation is expected to change as the access by global investors to the A-share
market has been expanded through Northbound Stock Connect. The asset management of
offshore institutional investors in A shares is expected to grow further after the inclusion of A
shares into global indices and the quadrupling of daily quota of net purchases under Northbound
Stock Connect. The increased global institutional participation is expected to increase the demand
for block trading of A shares.
In the Hong Kong market, the exchange’s manual trade mechanism accommodates the reporting
by Exchange Participants of block trades through private negotiations between brokers, internal
crossing or dark pools. The turnover of negotiated trades reached the highest in 2018. Evidenced
by the relatively high average transaction size, negotiated trades in the Hong Kong market are
believed to comprise mostly of block trades. The growth in block trading could, to a certain extent,
be attributable to the growth in asset and wealth management businesses in Hong Kong.
Moreover, Mainland investors have become increasingly interested in diversifying their portfolios
through mutual funds with exposures in Hong Kong stocks. The potential demand for block trading
from Mainland funds through Southbound Stock Connect is expected to grow further.
Given the growing potential demand for cross-border block trading and that cross-border trading
between the Mainland and Hong Kong markets is now conducted largely via the Stock Connect
schemes, it is worth considering the enhancement of Mainland-Hong Kong market connectivity
with block trading facilities under appropriate arrangements and controllable environment, so as to
meet investors’ demand. Cross-border market liquidity can thereby be further enhanced and
investors can benefit from even better execution.
FULL REPORT
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