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Under the Listing Rules, an issuer is required to appoint a liquidity provider to provide liquidity for every derivative warrant it issues.

How does a liquidity provider work?

A liquidity provider can provide liquidity for a warrant either by active quotes or quote request.

Active quotes:
Starting from 31 December 2012, all warrant issuers implement active quotes standards under which liquidity providers provide liquidity for certain derivative warrants 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.

Roughly speaking, the liquidity provider should provide active quotes for at least 90% of the time of a trading day for warrants that meet the criteria for active quotes. Each pause to provide liquidity should not exceed 10 minutes.

Active quotes only apply to warrants 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;
  • remaining time to expiry of at least one month; and
  • moneyness between 20% in-the-money and 20% out-of-the-money. "Moneyness" is derived by comparing the spot price or level of the underlying and the exercise price or strike level. You may check out more details from the Industry Principles on Liquidity Provision for Listed Structured Products.

If you want to know whether a particular warrant is eligible for active quotes at any particular time on a trading day, you may contact the issuer to ask if such warrant meets the above criteria.

Quote request:
The liquidity provider provides 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 for a quote via your broker at the phone number displayed on the designated page of the warrant, the HKEx website and the listing document.

Who can be a liquidity provider?

A liquidity provider must be an Exchange Participant, but needs not be part of the issuer's group of companies. An issuer can appoint different liquidity providers for different derivative warrants it issues. A liquidity provider can serve more than one warrants issued by the same or different issuers. However, each warrant 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 or 96XX. A liquidity provider uses the same Broker ID for all derivative warrants it supports.

To ensure market liquidity is not affected should the liquidity provider fail to perform its functions, an issuer may appoint a back up liquidity provider for contingency purposes.

How do liquidity providers fulfil their obligations?

A liquidity provider's obligations are specified in the respective listing documents. Starting from 31 December 2012, all warrant issuers also implement active quote liquidity in accordance with the Industry Principles.

However, there are certain circumstances specified by the issuer in the listing document under which it can suspend its obligation to provide liquidity. Examples include:

  • the warrant or the 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 financial markets experience exceptional price movement and high volatility over relatively short periods of time leading to a sudden increase in risk and uncertainty) which materially affects the issuer's hedging ability;
  • if the theoretical value of the warrant is less than HK$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 warrant available for market making activities;

As the circumstances may vary for different derivative warrants, 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 obliged 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?

The Stock Exchange evaluates the performance of liquidity providers. In case of any non-compliance with the obligations as set out in the listing document, the Stock Exchange may suspend the issuer from further issuance of derivative warrants or require the issuer to find another liquidity provider within a prescribed time period.

Besides, liquidity providers have to comply with the relevant securities regulations.

However, don't misunderstand the role of liquidity providers. Liquidity providers are only required to ensure some minimal liquidity in the market as and when it is needed. They are obliged to provide quotes on a limited scale usually after considering the supply and demand situation at the time.

As an investor, before you buy a warrant, it is in your best interest to also 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 warrant, whether its level of service is consistent over the life of that warrant.

To understand more about derivative warrants listed in Hong Kong, please refer to the frequently asked questions (FAQ) posted on individual issuers' websites or the HKEx website.