Residual odd lot execution

Residual odd lot¹ execution

This FAQ aims to provide further guidance and practical examples on the application of the circulars to licensed corporations ("LCs") issued on 14 February 2018 and 14 May 2019 (the "Circulars"), in relation to provision of facilitation services to clients in the execution of residual odd lots.

Q1 :
For LCs that pre-arrange with clients standing agreements for the execution of residual odd lot (i.e. residual of an order being less than one board lot) through client facilitation services (“Standing Agreement”), are they exempted from the requirement to obtain explicit client consent on a trade-by-trade basis prior to each client facilitation trade as stipulated in the Circulars?

The SFC is aware that some LCs may provide client facilitation services in relation to the execution of residual odd lot which arises under various circumstances (please see Annex for details).

In general, odd lots have lower liquidity than that of the same security in the board lot market. As such, some LCs offer client facilitation services for the execution of residual odd lot with a view to providing clients a potentially increased speed and likelihood of execution/ settlement.

Taking the above factors into account, the SFC will regard it as acceptable for LCs to have Standing Agreements with clients in respect to the execution of residual odd lot through LCs’ client facilitation services, provided that all other relevant regulatory requirements are complied with – including but not limited to, acting in the best interests of clients², the disclosure of conflicts of interest and to take all reasonable steps to ensure fair treatment of the client³. Hence, LCs are exempted from the requirement to obtain explicit client consent on a trade-by-trade basis prior to the execution of residual odd lot through client facilitation services.

For the avoidance of doubt, it shall be noted that there can only be one residual odd lot per any given parent order; and that the residual from any given parent order greater than or equal to one board lot shall not be regarded as a residual odd lot (even if such residual comprises of both board lot and odd lot). Please refer to Annex for examples of a residual odd lot for the purpose of this FAQ.

Residual odd lots as executed through a LC’s client facilitation desk shall nonetheless be clearly identifiable to both the clients, as well as the LC. The LC should establish internal guidance on the implementation and application of the Standing Agreement, including but not limited to – a clear definition of residual odd lot, pricing mechanisms as adopted by the LC to determine the execution price for residual odd lots arising from different types of parent order⁴ (“Pricing Mechanisms”), and adequate controls for detecting and addressing potential misconduct.

Q2 :
What should the Standing Agreement contain?

The Standing Agreement should, at a minimum –

Be clearly worded to emphasise that the exemption from seeking explicit client consent on a trade-by-trade basis, prior to each client facilitation trade, is only applicable for residual odd lot with no other variation allowed;
Clearly document, explain and agree with client the Pricing Mechanisms for facilitating clients’ residual odd lot trades;
Have a validity of not more than 12 months, and
Provide client the flexibility to revoke the Standing Agreement at any time.

The Standing Agreement which is not revoked prior to expiry, may be renewed with client’s written consent.

Footnote

[1] Securities of less than one board lot is commonly known as an odd lot in Hong Kong; and “residual odd lot” means the residual of an order being less than one board lot.

[2] General Principle 1 and paragraph 3.10 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (“Code of Conduct”).

[3] General Principle 6 and paragraph 10.1 of the Code of Conduct.

[4] For example, target benchmark price order, reference price order, or volume weighted average price (“VWAP”) order.

Annex

Below are some examples where an odd lot is to be considered as a residual odd lot for the purpose of this FAQ –

1. Residual shares after the execution of a parent order

Client places an order to sell 1,100 shares of Company A at a limit. Company A has a board lot size of 500 shares. Client has a Standing Agreement with the LC with respect to residual odd lot. A total of 1,000 shares are sold during the continuous trading session at the Exchange. A residual order for 100 shares remains outstanding. The 100 shares are considered as a residual odd lot. The LC’s facilitation desk may, at any time before the order expires, buy the 100 shares from client in accordance with the terms and Pricing Mechanism as agreed in the Standing Agreement with client.

2. Residual not less than one board lot (even if such residual comprises of both board lot and odd lot)

Client places an order to buy 1,000,000 shares of Company D at a limit. Company D has a board lot size of 1,000 shares. 998,800 shares were bought at a price better than limit off-exchange, through a match identified in an alternative liquidity pool. The shares of Company D have been trading at a price above limit on the Exchange until market closed. At the end of the day, a residual order for 1,200 shares remains outstanding, being not less than one board lot. In this scenario the residual order for 1,200 shares is not considered as a residual odd lot. The LC must obtain client’s explicit prior consent should the LC is to facilitate the execution of the 1,200 shares.

3. Odd lot order

Clients places an order to sell 900 shares of Company E at market price. Company E has a board lot size of 1,000 shares. The order is not to be considered as a residual odd lot. The LC must obtain client’s explicit consent prior to facilitating the order.

Last update: 18 Dec 2020