According to a research report released by CITIC Capital, on August 27th, the Chief Executive of the Hong Kong Special Administrative Region, Li Jiachao, announced that the government will establish a working group to study how to increase stock market liquidity, and Hong Kong stocks may face more policy benefits. Overall, the bank believes that a lower proportion of individual investors, higher transaction costs, and the lack of a market maker system in the stock market are the main reasons for the poor liquidity of Hong Kong stocks. Looking ahead, if measures such as accelerating GEM reform, reducing market transaction costs, introducing a market maker system, continuously expanding connectivity, and attracting more international capital participation are implemented, the liquidity of the Hong Kong stock market is expected to continue to improve.

At present, the Hong Kong stock market has less liquidity compared to the mainland China and US markets; Specifically, its liquidity differentiation is relatively obvious, with transactions showing a concentration towards the top; The liquidity of large market cap companies is significantly better than that of small market cap companies' stocks and the overall market, while the lack of liquidity of small market cap companies is an important reason for the liquidity gap between Hong Kong stocks and other markets.

Event: The Hong Kong Special Administrative Region Government has established a working group to study how to increase the liquidity of the stock market. On August 27th, the Chief Executive of the Hong Kong Special Administrative Region, Li Ka chao, announced that the government would establish a working group led by the Financial Secretary, Chan Mo po, to study how to increase the liquidity of the stock market. The relevant details are expected to be announced soon.

On the Liquidity of Hong Kong Stock Market

The overall liquidity of the Hong Kong stock market is relatively poor, and the turnover rate has been under significant pressure since 2023

As an Asian financial center, Hong Kong, China brings together global investors and high-quality enterprises mainly from mainland China, making it the only offshore market among the top ten global exchanges. However, the liquidity of the Hong Kong stock market is relatively poor. According to the World Federation of Exchanges (WFE), the ADT of the Hong Kong Stock Exchange in 2022 was $11.759 billion, with an annualized turnover rate of 62%. It is relatively low among major exchanges in the world, significantly lower than mainland China and the United States, but higher than India, the United Kingdom, France, and similar to Germany. In the first half of 2023, due to multiple factors such as overall market pressure and relatively tight liquidity, the daily trading volume of Hong Kong stocks decreased by 16% to HKD 115.5 billion; The daily average turnover rate was only 0.19%, with a year-on-year turnover of -0.03 pct.

The liquidity differentiation in the Hong Kong stock market is relatively obvious, and trading shows a significant concentration towards the top.

Overall, the liquidity of Hong Kong's large market cap companies has been significantly better for a long time, and Hong Kong stock trading has shown a significant concentration towards the top. If the stocks of Hong Kong listed companies with a market value of HKD 30 billion or more are referred to as large market value company stocks, and those with a market value of HKD 30 billion or less are referred to as small market value company stocks, then from the beginning of 2023 to August 25, the daily turnover rate of large market value company stocks in Hong Kong reached 0.36%, significantly higher than the overall 0.19% of Hong Kong stocks and 0.17% of small market value company stocks.

In contrast to Hong Kong stocks, small market value companies on the Nasdaq and Japan Stock Exchange have active trading and relatively good liquidity. If we examine the daily average turnover levels of different market segments on the Nasdaq and Japan Stock Exchange, the Nasdaq Capital Market, which mainly consists of small market capitalization and high growth companies, and the Tokyo Stock Exchange Growth Market, have achieved daily turnover rates of 4.42% and 2.31% since the beginning of 2023, significantly higher than the overall 2.23% and 0.80% of the Nasdaq and Japan Stock Exchange, as well as other market segments, Reflects the good market liquidity level of its small cap company stocks.

Due to the concentration of liquidity in the Hong Kong stock market mainly towards the stocks of top large cap companies, while the liquidity levels of stocks of small cap companies on the Nasdaq and Nikkei Stock Exchange are relatively good, the overall liquidity of stocks of large cap companies on the Hong Kong stock market is not poor. The difference in liquidity levels between the Hang Seng Index, the Nikkei 225 Index, the Nasdaq 100 Index, and other blue chip indices is much smaller than the overall market; The overall liquidity level of Hong Kong stocks compared to the Nasdaq and the Nikkei Stock Exchange may be mainly due to the relatively lack of liquidity in small cap company stocks.

Analysis of the Reasons for Poor Liquidity of Hong Kong Stocks

In summary, the bank believes that the reasons for the poor liquidity of the Hong Kong stock market can be attributed to: 1) a lower proportion of individual investors; 2) Higher transaction costs; 3) The stock market lacks a market maker system.

1) Firstly, from the perspective of investor structure, the Hong Kong stock market has a high level of institutionalization, with a small proportion of individual investors leading to a low level of market liquidity.

Generally speaking, due to the emphasis placed on long-term and value investment styles by institutional investors, their trading behavior is more rational and their turnover rate is much lower than that of individual investors. Therefore, in general, markets with a high proportion of individual investors tend to have more active transactions, while markets with a high proportion of institutional investors are relatively prone to facing the problem of poor liquidity.

Overall, the proportion of institutional investors in Hong Kong stocks is relatively high, with a lower level of institutionalization than US stocks but higher than A-shares and Korean stocks. According to the latest "Spot Market Trading Research Survey 2020" released by the Hong Kong Stock Exchange in April 2022, the investor structure in the Hong Kong stock market exhibits characteristics such as institutionalization and internationalization. In terms of institutionalization, 56.5% of the total trading volume of Hong Kong stocks in 2020 was contributed by institutional investors, with a year-on-year increase of 3.1 pct. Since the survey data was available in 2008, it has remained above 50%, indicating a high level of institutionalization in the Hong Kong stock market. According to statistics from the Federal Reserve, the market value of institutional investors' holdings reached 60.0% at the end of 2020 (which was the same as at the end of 2021), and has remained stable at over 60% since 2002.

2) Secondly, from the perspective of transaction costs, the Hong Kong stock market's transaction costs mainly based on stamp duty are relatively high, making it difficult to attract more types of investors and more transactions

Overall, lower transaction costs can attract more high-frequency traders and other investors to participate in market trading, thereby contributing a continuous flow of liquidity to the market; On the other hand, lower transaction costs can objectively promote existing investors to expand their trading scale, thereby promoting the improvement of market liquidity levels. Overall, the difference in trading fees between the Hong Kong Stock Exchange and other major exchanges is not significant. However, due to the high stamp tax rate imposed by the Hong Kong SAR government and the existence of transaction fees and stock exchange fees in the Hong Kong stock market, the overall trading costs are significantly higher than those of A-shares and US stocks. At present, the Hong Kong Special Administrative Region government charges a stock stamp duty of 0.13%, which is collected bilaterally from both buyers and sellers. The total stamp duty collected reaches 0.26% of the total transaction amount, which is 5.2 times the reduced amount in mainland China; Overall, the average trading rate of Hong Kong stocks ranges from 0.17% (for internet securities firms) to 0.39% (for traditional securities firms), with stamp duty accounting for a relatively high proportion; Its comprehensive trading rate is significantly higher than the 0.08241% (Shanghai Shenzhen Stock Exchange)~0.0915% (Beijing Stock Exchange) of A-shares and around 0.0016% of US stocks, making it difficult for investors of high-frequency trading and quantitative trading to carry out trading in the Hong Kong stock market, which has dampened their trading activity. According to data from the Hong Kong Financial Development Authority, in 2020, large traders such as market makers, high-frequency traders, quantitative funds, and hedge funds accounted for 67.9% of the total market trading volume in the United States, while in Hong Kong, China, this proportion was only 28.1%.

3) Finally, from the perspective of market mechanisms, there is no competitive market maker system in the Hong Kong stock market to ensure a good level of market liquidity

In the United States, in order to improve market liquidity and increase market share of trading business, NASDAQ adopts a system of bidding and competitive market makers. According to Nasdaq regulations, each stock listed on the Nasdaq must have two or more market makers providing market making services. Market makers obtain treasury stocks through IPO placements or purchases from the public market, and provide competitive bilateral quotes. Investors can choose the best market maker to trade. At present, there are over 500 market makers providing market making services for stocks of companies listed on NASDAQ, with an average of 14 market makers per stock. Due to sufficient market competition and the high liquidity rebate compensation of NASDAQ, market makers need to continuously optimize their quotes to obtain an increase in transaction amount, and investors can also quickly find the optimal price for trading. Therefore, the bid-ask spread and trading efficiency of the Nasdaq market are at a relatively optimal level. The faster trading speed and better bid-ask spread have also attracted more investors to trade on NASDAQ, thereby promoting the improvement of liquidity in the NASDAQ market.

At present, the Hong Kong Stock Exchange has established a market maker mechanism under mechanisms such as the exchange traded product (ETF) market and the Hong Kong dollar RMB dual counter model, and has implemented exemption measures for transaction fees and stamp duty; Market makers provide liquidity to the market by continuously submitting bilateral quotes for the purchase and sale of relevant securities to investors, and accepting their buying and selling requirements at that price level. According to the instructions of the Hong Kong Stock Exchange on the responsibility of the market makers, the price difference between the buying and selling bilateral market orders inputted by the market makers into the system should be controlled within a certain range, and the minimum quoted value of the market makers should also meet relevant requirements; Therefore, generally speaking, investors are expected to quickly complete transactions at reasonable prices in the corresponding market, thereby ensuring sufficient liquidity of related securities. At present, the ETF dealer and dual counter dealer mechanisms are operating well, and the ADT of the Hong Kong Stock Exchange's ETF has increased from HKD 5 billion in 2019 to HKD 13.9 billion, with a compound annual growth rate of 29%; As of August 25th, under the continuous market making of dual counter makers, the total ADT of all 24 RMB counter securities reached 1.5 billion yuan, accounting for 0.53% of their total dual counter ADT, and the price difference between the RMB and Hong Kong dollar counters of all 24 securities remained within 1%. However, at present, the banker mechanism has not been implemented in the spot market, so the overall Hong Kong stock market cannot benefit from the abundant liquidity brought by the continuous market making of market makers, making it difficult to achieve an improvement in liquidity levels.

Looking ahead, the improvement of liquidity in the Hong Kong stock market is expected

1. The reform of the Growth Enterprise Market (GEM) is expected to accelerate, enhancing the liquidity and attractiveness of stocks of small and medium-sized market capitalization companies

As mentioned earlier, the liquidity differentiation in the Hong Kong stock market is relatively obvious, with transactions showing a significant concentration towards the top; However, the trading of stocks of small and medium-sized companies is relatively bleak due to a lack of investor attention; The low turnover rate of stocks of small and medium-sized market capitalization companies is also one of the important reasons why the overall liquidity level of Hong Kong stocks lags behind other markets.

Therefore, to enhance the overall liquidity level of the Hong Kong stock market, it is necessary to enhance the liquidity of small and medium-sized company stocks and their attractiveness to investors. To promote the improvement of the trading situation in the secondary market of small and medium-sized companies' stocks, strict screening and quality control on the asset side are essential. At present, the overall fundamental situation of companies listed on the Hong Kong GEM is poor. As of the end of 2022, there were a total of 340 listed companies on the GEM, with an average market value of only HKD 250 million; Among them, only 98 companies achieved profitability in 2022, accounting for 28.82% of the overall ChiNext market; Therefore, the relatively poor quality of listed companies makes it difficult for the ChiNext to attract investors, especially institutional investors. On the other hand, to enhance the liquidity and attention of small and medium-sized company stocks, it is also necessary to involve more institutional investors. With the advantage of large funds, if institutional investors participate more in the trading of small and medium-sized company stocks, it can easily significantly improve their market trading volume and liquidity level. In addition, due to the mature investment system and strong research resources of institutional investors, their participation will significantly enhance the market transparency and attention of small and medium-sized company stocks, thereby further promoting the improvement of their liquidity level.

Previously, the Financial Secretary of the Hong Kong Special Administrative Region Government, Chen Maobo, pointed out in the government's "Financial Budget" for the fiscal years 2023-24 that the Hong Kong Stock Exchange will propose specific reform proposals on GEM and conduct formal consultations within this year. According to the Secretary for Financial Affairs and Treasury of the Hong Kong Special Administrative Region Government, Xu Zhengyu, he has requested the Hong Kong Stock Exchange to "comprehensively consider relevant matters, including reviewing the listing system and secondary market trading mechanism". It is expected that the attractiveness of GEM to issuers and investors will significantly increase in the future, driven by relevant measures. In the future, more high-quality issuers will list on GEM and more institutional investors will participate in GEM trading.

2. Market transaction costs are expected to decrease, attracting more investors to participate and encouraging more transactions

The impact mechanism of market transaction costs on market transaction activity is relatively clear and significant. As mentioned earlier, the transaction costs in the Hong Kong stock market, including stamp duty, are currently high. The stamp duty rate charged by the Hong Kong SAR government for stock transactions is 0.13%, and it is a bilateral charge for buying and selling. There is a significant difference in transaction costs compared to the US stock market after the removal of stamp duty, and it is also significantly higher than the 0.1% before adjustment and 0.05% after adjustment in mainland China, which is not conducive to quantitative investment The participation of high-value traders such as high-frequency trading in the Hong Kong stock market is also not conducive to the increase in transaction activity of existing investors. Previously, the Hong Kong Securities and Futures Association had publicly called for the Hong Kong government to revoke the stamp duty on stock trading; On August 27th, the Chief Executive of the Hong Kong Special Administrative Region, Li Jiachao, in response to reporters' inquiries about whether he would reduce the stock stamp duty, also stated that "different possibilities will be studied". If the Hong Kong stock stamp duty is lowered in the future, it may be possible to attract more types of investments, including quantitative investment and high-frequency trading, to participate in Hong Kong stock trading. At the same time, it is also possible to encourage existing participants to trade more, To help enhance the long-term competitiveness and liquidity level of the Hong Kong stock market.

3. If the market maker system is widely introduced, it is expected to provide more liquidity for the market

Objectively speaking, compared to stocks of large star companies, stocks of small and medium-sized market capitalization companies have relatively low market attention. Due to the lack of investor participation, they are more likely to experience situations such as delayed order execution and large bid-ask price differences. In turn, this may further suppress investors' enthusiasm to participate in stock trading of small and medium-sized market capitalization companies, which is not conducive to the improvement of their market liquidity. Active market makers can serve as liquidity providers, continuously providing bilateral quotes to the market and accepting trading requirements from investors, thereby improving the execution speed and certainty of transactions, and reducing the bid-ask spread, thereby injecting sufficient liquidity into the market. From the successful experience of NASDAQ, it has ensured the good liquidity of stocks traded on NASDAQ, especially stocks of small and medium-sized companies, through high trading returns and effective competitive market maker systems, thereby gradually increasing the market share of trading business. In the Hong Kong stock market, the banker mechanism introduced by the ETF products and the dual counter model of the Hong Kong Stock Exchange has also made a very positive contribution to the improvement of market liquidity; The continuous and healthy operation of the banker mechanism has also accumulated rich experience for market infrastructure providers such as exchanges, market participants such as brokers, and regulatory agencies, providing conditions for the smooth operation of possible banker mechanisms in the future. If an effective market maker mechanism can be introduced in the future spot market of the Hong Kong Stock Exchange, it is expected to significantly improve the current unfavorable situation of insufficient liquidity and long-term low transaction volume in some Hong Kong stocks, thereby helping to enhance the overall liquidity of the Hong Kong stock market.

4. Continuously expanding connectivity and actively attracting more international capital to participate

As a typical offshore market, in order to further enhance the trading volume and liquidity of Hong Kong stocks in the future, it is necessary to attract more international capital to participate. At present, the market value of shares held by foreign investors in the Hong Kong stock market is relatively high; 2020 Hong Kong