Futures Market: Hong Kong Experience

Prof. Stephen Yan-Leung Cheung

City University of Hong Kong

Content

Asian Financial Crisis (1997-1998)

What happened

Consequences

Aftermath

Lessons

What Happened?

Inflated asset price– Fell by 60%

Potential recession– 1998 Q3 GDP ↓6.9%

Other Asian currencies have sharply depreciated Market perceived that HK dollar was undervalued Hong Kong dollar is linked with US dollar with

US$1 vs HK$7.8

What Happened? Pressures began in October 1997 on the forward

rates for the HK dollar and regulated in a sharp full in equity market

Pressures continued periodically through the first half of 1998– Weakness in domestic economy– Yen had fallen to an 8-year low of 147 per US$– Renewed concerns an possible depreciation of RMB

In 1998. equity prices had fallen over 55% from their peak a year earlier, 12-month forward rate on the HK dollar was depreciated by 8% compared to 7.8 which is the official rate of HKD

Double Play

Taking short position in the equity market– Short-selling stock– Short HSI futures contract– Put option on HSI

Putting upward pressure on the forward rates for the Hong Kong dollar

→ sharp fall in equity market

Chart 1 HSIF Open Interest and 3-month Hong Kong Dollar Forward

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Chart 1 HSIF Open Interest and 3-month Hong Kong Dollar Forward

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Chart 2 HSIF Volatility and 1-month HIBOR

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HSIF Volatility 1m HIBOR

Currency market

Short position in the HK dollar may have established to over US$ 10 billion (6% of GDP) by institutions– SWAP-driven issuance of HK dollar dominated

securities by international financial institutions in the first eight months of 1998

– Concentrated selling intended to move the exchange rate beyond the official exchange rate

– Market rumors on devaluations of the HK dollar

Derivatives market

Activity on HSI futures contract rose from April to August 1998

4 hedge funds whose futures and options positions accounted for 40% in early August 1998

Their positions accounted for 49% of the total; one fund accounted for one-third

Source: Report of the Work Group on Highly Leveraged Institutions (Financial Stability Forum 2001, BIS)

Consequences

HKSAR government’s intervention in the market during 14-28 August, US$ 15 billion in equities, led to the creation of HK tracker fund

Subsequent improvement in the global outlook, the large hedge fund HSI futures positions were mostly unwound in October

Risks

Futures market

– Concentration risk, a big concern?

– Definitely yes for the economy, because of systematic risk

Aftermath

Open position limit

Margin requirement

Super-margin requirement

Lessons (1)

Communication channels between HKFE and SFC

Coordination between regulators

– Cross-market surveillance Committee

Market Intelligent System

Lessons (2)

Education on products

Investors

Regulators

Intermediaries

‘Big elephant jumped into a small pond.’

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