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Changes to Result in Better Framework and Incentive Structure for HKFE Market Makers HKEx plans to introduce a new Market Maker (MM) model for its Hong Kong Futures Exchange (HKFE) products and revised trading fee discounts for MMs’ trading in stock index futures or options, with the changes scheduled to take effect 1 February next year. • MMs who wish to carry MM positions in a client account must make arrangements with one or more other corporate entities as client(s). Such corporate entities will be subject to the following eligibility requirements and the MMs must demonstrate their suitability and qualifications: New Market Maker Model The new MM model is designed to simplify and improve the quality of market making services. It focuses on registration and responsibility of Exchange Participants (EPs) for MM activities and will discontinue registration of third parties known as Registered Traders (see chart on next page). The main features of the MM model are summarised below. − be a regulated entity (excepting introducing agents); − be a licensed bank; − have a credit rating of A- or above (Standard & Poor’s) or A3 or above (Moody’s); or − have minimum paid-up capital of $50 million and minimum shareholder funds of $100 million. • Only HKFE EPs will be registered as MMs and they will be held responsible for the relevant market making activities. To be registered as MMs, relevant EPs must apply and demonstrate to HKFE that they are proficient in market making activities. The MM must ensure that the corporate entity fulfils all the MM requirements and obligations. If a corporate entity fails to comply with the requirements and obligations, the arrangement of the MM with the corporate entity to make markets may be discontinued. • MMs must provide quotes in response to quote requests or on a continuous basis for the market in which they are registered. They may enjoy trading fee discounts and other benefits if they meet their stipulated obligations. • All Client Registered Traders and Employee Registered Traders will be deregistered at the effective date of the new rules and the existing tripartite agreement they registered under will be terminated. • The standardised term Market Maker will be used to refer to EPs registered with HKFE to perform MM activities. Most EPs currently participating in market making are not expected to encounter difficulties under the new model. They will be deemed as MMs upon submission of a simple application, though HKFE may at the time of application request documentary evidence showing they are able to comply with the new model. October 2006 11 Changes to Result in Better Framework and Incentive Structure for HKFE Market Makers Registered Traders for HKFE Products (as of 30 September 2006) Client Registered Traders — Individuals 2 Client Registered Traders — On Behalf of Corporations (Representing 14 Corporations) 47 Revised Trading Fee Discounts for Market Makers Trading in Stock Index Futures or Options HKFE has prepared a revised trading fee discount scheme for MMs trading in stock index futures or options. Under existing HKFE Rules, Registered Traders (RTs) in a stock index futures or options market enjoy discounted trading fees in that market when trading for their own market making accounts. In addition, they enjoy discounted trading fees when trading in all other index futures and options (Other Markets) when trading for their own market maker accounts. The purpose of this planned revision of the trading fee discounts is to ensure there will be adequate and appropriate incentives for market makers in the stock index futures and options markets. The following is a summary of the revised trading fee discounts (note the term “RT” will be replaced by “MM”): 1) MMs in a stock index futures or stock index options market will be eligible for trading fee discounts in Other Markets only when such markets have the same underlying index (for example, Hang Seng Index (HSI) Futures/Options and Mini-HSI (MHI) Futures/Options are contracts having the same underlying index); 12 October 2006 Employee Registered Traders (Representing 14 Exchange Participants) 51 2) Subject to (3) below, the maximum number of contracts eligible for trading fee discounts in Other Markets in each calendar month is the respective MM’s trading volume in the stock index options or stock index futures market in which the MM is making a market; 3) For an MM in MHI Futures or Options, the maximum number of other eligible transactions in the HSI Futures/Options shall be multiplied by one-fifth, according to the MHI-to-HSI contract size ratio; and for an MM in the HSI Options, the number of other eligible transactions in the MHI Futures/Options shall be multiplied by five, according to the HSI-to-MHI contract size ratio; and 4) Any monthly trading volume exceeding the maximum number mentioned in (2) and (3) will be subject to a monthly claw-back of the “excess” discounted amount. This is in addition to the existing claw-back of trading fee discounts where an MM fails to meet its obligations.