Market Microstructure could play a role in effecting important factors such as the rationality of investors and the liquidity of securities. These factors have an effect on systematic risk of securities, thereby it affect assets pricing. This chapter describes a brief history of Bursa Malaysia and the state of Bursa Malaysia microstructure as on December 31 2008, thereof to cover the whole image regarding the trading mechanism and trading rules of Bursa Malaysia. Thus, the current chapter reviews the trading mechanism in terms of market type, price discovery, order forms and degree of transparency and trading regulations currently implemented in Bursa Malaysia. Finally the key changes in Bursa Malaysia market microstructure are presented at the end of this chapter.
Bursa Malaysia: A Brief History
The securities industry in Malaysia has long history which began in 1870s, as an extension of the British corporate presence in the rubber and tin industries. Trading securities in Malaysia through organized exchange begun in 1930 when Singapore Stockbrokers' Association was established. In July 1973, the stock Exchange of Malaysia and Singapore was divided into the Kuala Lumpur Stock Exchange (KLSE) and the Stock Exchange of Singapore. The KLSE was incorporated under the companies Act of 1965 (Sinnakkannu and Nassir, 2006). The KLSE has demutualised on 5 January, 2004. Since April 2004, the name of KLSE has changed to Bursa Malaysia Berhad and Bursa Malaysia has been listed on March 2005.
The Bursa Malaysia growth has accelerated markedly in the past twenty years. As on December 31 2008, 977 companies were listed on the Bursa Malaysia. From those, 634 companies were listed on the main board, 221 were listed on the second board and 122 companies were listed on the MESDAQ Market.
In total, as on December 31 2008 these companies had a market capitalization of $189 billion and total value of share trading of $93 billion as shown in Figure 2.1 which illustrates the market capitalization and value traded of Bursa Malaysia from 1990 to 2008 in millions US$.
Figure 2.1 Total value of share and domestic market capitalization of Bursa Malaysia adapted and adopted from (WFE, 2007)
The main stock index of Bursa Malaysia is the Kuala Lumpur Composite Index (KLCI) which was introduced in 1986 in order to reflect the Malaysian stock market performance. KLCI is a capitalization-weighted index and comprises of the multi sector companies. Figure 2.2 illustrates the KLCI movements from 1990 to 2008.
Bursa Malaysia Market Microstructure
The market microstructure research is important for illustrating the behavior of prices and markets, which has direct influence on the market regulation, and in the design and formulation of trading mechanisms (O'Hara, 1995). Market regulations dictate how and when orders can be submitted and how orders are processed, consequently it determine how prices are formed. Changing in the market regulation can be simply implemented by securities exchange, while the changing in trading mechanisms requires real investment and takes time to be implemented, therefore in this study market microstructure dimensions have been classified according to trading mechanism and trading regulation.
Trading Mechanism
Trading mechanisms refers to the methods of trading securities. They are determined by several diminutions including market type, price discovery, order forms and degree of transparency.
Market Type
Securities market type has three dimensions which are degree of continuity, reliance on market makers and degree of automation (Madhavan, 2000). With regard to the degree of continuity , there are two types of market: the first one is the 'call market' where selling and buying orders are grouped together during an interval period of time and transact at single price, which equates the quantity supplied to the quantity demanded. The second one is the continuous auction market, where selling and buying orders are executed whenever submitted. The executing price represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to sell (Chang et al., 1999). With respect to the reliance on market makers, securities exchange considered as quote-driven market where prices are determined from quotations made by market makers or specialists. While securities exchange considered as order-driven market or auction market where prices are determined by the publication of orders to buy or sell shares via public investors without market makers' intermediation. (Madhavan, 2000).
Concerning the degree of automation, trading mechanisms can operate either on the floor or by means of electronic systems. Regarding the first type, trading mechanism relies on an open outcry method where exchange uses face to face verbal and hands signal. In the second type, trading mechanism employs an electronic trading system where participants key in the orders.
With these multidimensional market types a plethora of choices for the trading of securities are available to the securities exchanges. Table 2.1 represents the market type of Bursa Malaysia. Currently, regarding degree of continuity, Bursa Malaysia uses call market in the pre-opening and pre-closing trading phases, and continuous auction during continuous trading phase. With respect to reliance on market makers, currently there are no market makers or specialists existed in Bursa Malaysia, thereby the prices are determined in the terms of orders arriving at a central trading system. Turning to the degree of automation, the present process of trading in Bursa Malaysia operates by a central and fully computerized order matching system, which accumulates keyed in orders by brokering companies (Ramiah et al., 2008).
Table 2.1 The market type of Bursa Malaysia.
Degree of Continuity
Market Opening and Closing Mechanism
Call Auction
Intraday Trading
Mechanism
Continuous Auction
Reliance on Market Makers
Market Opening and Closing Mechanism
Order driven
Intraday Trading
Mechanism
Order driven
Degree of Automation
Market Opening and Closing Mechanism
Electronic system
Intraday Trading
Mechanism
Electronic system
Trading Sessions and Price Discovery
A trading session is a defined period of time, consists of several phases from the pre-opining phase to the closing phase where the trading of securities may take place. Each phase within trading session implies a process of trading and price discovery under explicit trading rules.
Trading in Bursa Malaysia is open for 5 days a week from Monday to Friday, except for public and other market holidays. Bursa Malaysia splits the trading day up into a morning and afternoon session from 9:00 to 12:30 and from 14:30 to 17:00 respectively. Each trading session goes through a series of phases which are opening, continuous trading, pre-closing, closing and trading at last, thus, there is a total of 6 trading hours each working day. In addition, there are pre-opening phases in the morning from 8:30 to 9:00 and in the afternoon from 14:00 to 14:30 each working day, as shown in Figure 2.2.
Figure 2.2 Trading sessions in Bursa Malaysia adapted from (BMSB, 2007).
The trading session starts with pre-opening phase. In this phase of trading, market orders and limit orders are allowed to be entered; all orders are submitted and batched for execution at the Theoretical Opening Price (TOP) which is calculated and displayed in real-time to the market for each security by the trading system, but transactions are not taken place before opening the session. During this phase, brokers also may continue to enter, modify and delete orders. Order entries, modification and deletion may change the TOP, when these occur, the system would determine the new TOP and display it to the market. The TOP of a stock is the single equilibrium price at which the most trades can be executed and used to determine opening as well as the initial price after a trading halt and forbidden trading status occurs. When the pre-opening period completed, trading system would automatically execute and match orders at opining price, which is the last TOP, then trading would proceed to continuous phase (Ramiah et al., 2008).
A continuous auction is used during the continuous trading phase, in this type of auction; orders can be entered, modified and deleted; Matching will be based on price and time priority; Market orders and limit orders are allowed to be entered; Matched bids and asks orders are auctioned off continuously. Matched orders are dispatched from the system, whereas unmatched orders remain in the system until they are executed or canceled. The transaction quotations during this phase are published to the market in real time (Ramiah et al., 2008).
Continuous trading phase extends to pre-closing phase where market orders and limit orders are allowed to be entered, thereby all orders are submitted and batched for execution at a Theoretical Closing Price (TCP) which is calculated and displayed in real-time to the market for each security by the trading system. No transactions are taken place in this phase before the closing of session. Brokers can continue to enter, modify and delete orders during this phase. Order entries, modifications and deletions may change the TCP. When this change occurs, the system will determine the new closing price and display it to the market. The TCP of a stock is the single equilibrium price at which the most trades can be executed used to determine closing price. When the pre-closing period is completed, trading system will automatically execute and match orders at closing price as the last TCP, then trading will closed, and automatically proceed to trading at last phase. During the trading at last phase traders can only enter limit orders, that are matched according to time priority at the closing price (Ramiah et al., 2008).
Order Forms
A trader in stock market can contact a brokerage firm to place an order, which represents the intent of the trader to sell or buy a specific stock listed in the secondary market. In reality, traders have several options when it comes to placing an order to buy or sell securities with regards to order types. Orders are contingent on a variety of conditions concerning quantity, price and time, whereas the most commonly used types of order are the market and limit orders.
Market order is a quantity contingent order used to immediately buy or sell a stock at the best bid or ask price currently available in the market. Market orders are always guaranteed to be executed as long as there are active buyers or sellers in the market. The market order guarantees the quantity but not the price, especially in fast moving markets. The order in fast moving markets might be executed at different price from real-time obtained price. This drawback in market order can be overcome by placing a limit order. Limit order is price contingent order to buy or sell a stock at a specific price outside the range of the current quotes. This type of orders allows traders to control and guarantee the price at which the trade is executed, but it is not guaranteed to be executed unless the specified price is reached.
Another price contingent order is stop order which allows trader to protect profits or stop loss. The stop order is an order to buy or sell a stock when the price of the stock reaches a specified price known as the stop price. When a current price reaches stop price, the stop order becomes a market order. A buy stop order is always placed at a price above the current market price typically used to limit a loss or protects a profit on short sales. A stop sell order is always placed below the current market price and it is used to stop loss or protects profits.
Stop limit order is a price contingent order to buy or sell a stock that combines the features of a stop order and a limit order. This order turns into a limit order when the stop price is attained. Stop limit order gives traders more control of when and at what price the order will be executed.
Additionally, there are other types of orders used to control price, quantity or execution of trade, such as fill or kill order, which is a market or limit order to buy or sell a certain stock for a specified quantity immediately, in case the order is not executed in its entirety, it will be automatically cancelled. Another type orders is called all or nothing, which is a limit order used to a buy or sell full amount of quantity or not at all, in case there is insufficient quantity at a specified price the all or nothing order unlike the fill or kill order, it is not cancelled and it remains on the order book as a limit order.
All orders are day orders, that is, valid on and for the day it is placed, unless otherwise specified. However, the trader can place good till cancelled order usually is a limit or stop order, which it remains valid until executed, canceled or expired after a specified period. Moreover the trader can specify at what time the order will be executed. For example a trader can place market on opening order in the pre opining trading phase, this order would be executed at the opening of the trading session at an opening price, also the trader can place market on closing order in the pre closing trading phase, this order will be executed at the closing phase at closing price.
Trading process in Bursa Malaysia begins when an authorized trader, who has a trading account and a central depository system account via a stock broking company, gives his broker an order to buy or sell a specified number of stocks of a certain listed company at a specified price and order type. Thereby the orders are keyed into the trading system terminal at the stock broking company. The orders go through the trading network to the Bursa Malaysia trading system and immediately the order confirmation is routed back to the stock broking company (BMSB, 2008 -d). The current trading system implemented in Bursa Malaysia provide a wide variety of order types such as market, limit, fill or kill, market on opening, market on closing, stop, orders but only a few order types are active. The trader currently can place orders to buy or sell securities in Bursa Malaysia in the morning session phases, and the same is true for afternoon session as revealed in table 2.2.
Table 2.2 Order types in each trading phase in Bursa Malaysia.
Trading Phase
Order Types
Pre-Opening
Market order
Limit order
Continuous Trading
Market order
Limit order
Pre-Closing
Market order
Limit order
Trading at Last
Limit order
Through the pre-opining trading phase market and limit orders are allowed to be entered; these orders are executed at the opening of trading at TOP. During the continuous trading phase market and limit orders are allowed to be entered. Each incoming order is checked immediately for possible execution in this phase. Market and limit orders are allowed to be entered in pre-closing trading phase. These orders are executed at the closing phase of trading at TCP. In the trading at last phase only limit orders can be entered.
All entered orders electronically are transmitted to the trading system. The trading system would then match these prices and orders. Once matching is completed, trading would confirm the successful transactions back to the broker and also disseminate the same data to the market. The broker in turn confirms with his client the transaction details. The system also transfers the trading details to securities clearing automated network system (SCANS) for clearance. Transaction clearance between brokers takes place by bursa securities clearing (BSC), which is a subsidiary of Bursa Malaysia. Transaction cleared on three working days according to T+3 rolling settlement system. Therefore, all payments are made by the brokers, on behalf of their clients to the bursa securities clearing through fully automated banking and the central depository system.
Transparency
Market usually is transparent when high quantity and quality of information regarding current and past prices, quotes, depths, volumes and the identities of market participants are rapidly available to the public. In this sense 'market transparency refers to the ability of market participants to observe information about the trading process'(O'Hara, 1995). When discussing market transparency, it could be divided into pre-and post-trading dimension. Pre-trading transparency refers to the dissemination of information about the limit-order book, bid and ask quotations, orders flow, identities of market participants, market depth. Post-trading transparency refers to the availability and velocity of dissemination of the information to the public about trading details such as volumes, prices, trader identities and transaction time.
Bursa Malaysia provides high level of information in real-time to the investors and brokers about pre-trading, which includes: 5 best prices of limit order book, indicative auction price (IAP), indicative equilibrium volume (IEV), market depths, whereas the hidden order is not allowed and no broker ID displayed. With regard to the post-trading, Bursa Malaysia disseminates real-time information to the investors and brokers on trading activities, which includes: transactions prices, volumes, inside trades and off-market trading. Bursa Malaysia permits some exceptions to the immediate reporting of the off-market trades. Table 2.3 illustrates Pre- and Post- transparency of Bursa Malaysia
Table 2.3 Pre- and Post-Transparency of Bursa Malaysia.
Pre- Trade
5 best prices of limit order book
Market Order
Indicative Auction Price (IAP)
market depths
Indicative Equilibrium Volume (IEV)
Post -Trade
5 Best Prices
Market Order
Transactions prices
Volumes
Inside Trade
Off-market trading
Market Regulations
Market Regulations refer to the rules of trading securities defined by securities market to control various aspects of trading process, such as the rules of order priority, tick size and spread, listing, market segment, price thresholds, trading status, short selling and off-market trading.
Rules of Order Priority
Matching of security orders priority is given according to certain criteria determined by securities exchange. Since the quantity contingent orders match at the best available prices, they are given priority and executed before price contingent orders. For instance, price and time priority rules take place in the continuous auction markets where market rules often require the highest of bid or lowest of ask price order received to be executed first. In case of two bids or asks are received at the same price, the first entered bid or ask order is given priority and is executed first. Unlike the continuous auction markets, the dealer markets do not operate under price and time priority rules. In this type of markets, it is a sine qua non for brokerages to seek the preferable prices for trader orders.
Bursa Malaysia during continuous trading phase is considered as continuous auction market, and the market orders have priority over limit orders. Price and time priority rules are applicable during intraday trading mechanism, whereby price priority means that the higher the bid price the better the chance, it will be matched by a seller, likewise, the lower the ask price the better the chance, it will be matched by a buyer. Time priority means that if there are multiple orders with the same price, the time at what the order was entered will become a factor in determining order which has matching priority. Market on opining orders are given a priority over Limit orders at the last generated TOP when the market opens. Market on closing orders are given a priority over Limit orders at the last generated TCP when the market closes (BMSB, 2008).
Rules of Tick Size and Spread
The minimum change allowed by the stock exchanges in the price, a security could have either up or down, is known as a tick size. Tick size could be in decimals or fractions such as eighths or sixteenths; it could also be fixed or varied within different price ranges. Tick size is an important factor determining the bid ask spread, which is the difference between a security's bid price and its ask price. The size of the spread is attributed to liquidity and transparency of the market, that is, more liquidity and transparency in the market bring bid ask spreads lower. In quote driven market, dealers buy stocks at the ask price and sell at the bid price. Thus, the size of the bid-ask spread is proportional to the size of the dealer's profit.
Bursa Malaysia applies decimals tick bids and asks for shares within various price ranges and different minimum bids as revealed in table 2.4 (BMSB, 2008 -c).
Table 2.4 the minimum bids for the different price ranges in Bursa Malaysia
Market Price of Share
Minimum Bids
Below RM1.00
1/2 sen
RM1.00 up to RM2.99
1 sen
RM3.00 up to RM4.98
2 sen
RM5.00 up to RM9.95
5 sen
RM10.00 up to RM24.90
10 sen
RM25.00 up to RM99.75
25 sen
RM100.00 and above
50 sen
Rules of Listing
Securities exchanges have listing requirements to approve listing shares of companies in accordance with listing rules. Securities exchanges have different sections where companies would be listed. Securities are allocated to a particular section of market whereby different trading mechanism and trading rules are carried out based on a number of criteria such as company size, liquidity and trading activities.
Bursa Malaysia requires the listed companies to comply with disclosure requirements so that investors are able to make informed decisions. The listed companies are distributed into main board, second board and MESDAQ market. The distribution is based on different listing requirements: large capitalized companies listed on the main board, medium sized companies listed on the second board (BMSB, 2008 -a) and high growth and technology companies listed on MESDAQ market (BMSB, 2008 -b). Table 2.5 shows the minimum issued and paid-up share capital required for listing in Bursa Malaysia.
Table 2.5 the minimum issued and paid-up share capital required for listing in Bursa Malaysia.
Main Board
Second Board
MESDAQ
RM 60 million (USD16.1022 million)
RM 40 million (USD10.7348 million)
RM 2 million (USD0.5367 million)
RM 20 million
(USD 5.3674 million) For Technology Incubators
Rules of Market Segments
Trading of securities in Bursa Malaysia is conducted in the four market segments which are: first, normal lot market where securities traded in board lot (100 unit per lot); second, odd lot market where securities traded in a quantity from 1 to 99 units; third, buying-in normal market where a participant organization, having sold securities, fails by the scheduled delivery time to make available in the relevant securities account, thereby Bursa Malaysia, directly buy-in against the concerned participant organization, without notice at T+3; and the fourth is the direct business transaction (DBT) market (Off-market trading) where transactions of share conducted outside the formal exchange, for example crossing transaction between two participants (Ramiah et al., 2008).
Rules of Price Thresholds
Price threshold refers to the range of price movement (maximum price increases or decreases) from the previous closing price permitted by securities exchange during one trading session or one trading day.
Bursa Malaysia uses price thresholds rules to control the movement of prices. The price range of securities is determined upon the reference price which in most cases is the previous trading session's last done price. If the reference price is above RM1, then the limit-up price movement is 30 percent of the reference price and the limit-down is 30 percent of the reference price. If the reference price is below RM1, then a limit-up is absolute RM0.30 above the reference price and the limit-down is absolute RM0.30 less than the reference price. These thresholds are valid at least for one session (Ramiah et al., 2008).
Rules of Trading Status
Securities exchanges use specified rules in certain circumstances that require ceasing the matching of one stock or securities group. Such process usually anticipates a news announcement or corrects an order imbalance. Implementing such rules would increase the market efficiency by giving all investors equal opportunities to evaluate news and make either buying, selling or holding decisions which are based on the arrival of new information.
Bursa Malaysia applies rules of trading status in order to control the trading activates. The current status rules of securities implemented in Bursa Malaysia could influence a group of securities. The trading status of the group securities is threefold: first, the normal status of trading is authorized when the orders relevant to the securities group could be entered, modified, cancelled and matched. Second, the interrupted status indicates that orders relevant to the securities group could be entered modified and cancelled, but would not be matched. Third, the forbidden status indicates that orders related to the securities group would not be entered, modified, cancelled or matched. The change of trading status depends on the certain circumstances that affect the group of securities. The table 2.6 illustrates the trading status and the circumstances when it is used (BMSB, 2008).
Table 2.6 the trading status and when it is used. adapted and adopted from (Ramiah et al., 2008).
Trading Status
when it is used
Authorized
When market is in normal situation
Interrupted
When the circuit breaker for the securities market is triggered at the first level (more than 10 % but less than 15%) or is triggered at the second level (more than 15% but less than 20%)
Forbidden
When the circuit breaker for the securities market is triggered at the third level (equal or more than 20%).
In addition to the foregoing, the trading status of a particular security is also determined by Bursa Malaysia depending on certain trading rules. The trading status of the particular security is also threefold: first, the normal status during the trading session is open when the orders with respect to the security could be entered, modified, cancelled and matched. Second, the reserved status indicates that orders concerning the security could be entered, modified and cancelled, but orders machining would be denied (similar to the security status in the pre-opening phase). Third, the suspended/frozen status indicates that orders regarding the security would not be entered, modified, cancelled and matched (BMSB, 2008). The trading status of a particular security is changed according to certain circumstances affecting the security as revealed in table 2.7.
Table 2.7 the trading status of a particular security and when it is used. adapted and adopted from (Ramiah et al., 2008)
Trading Status
when it is used
Open
When security is in normal situation during trading session
Reserved
When opening price of the securities is outside threshold
When Market order for the securities is not fully executed
When only one Market Order in the order book for the securities
Suspended / Frozen
When opening of trading of the securities has been delayed because of unusual circumstances.
When Bursa Malaysia has been advised that the issuer of the securities is about to make a corporate announcement.
When trading in the underlying securities (for warrants, structured warrants, loan stocks and indices) have been suspended.
Rules of Short Selling
When an investor anticipates that the price of a certain stock will rise up in the future, buying and holding the security could be the best strategy. Conversely, when an investor believes that the price of a certain stock will decrease in the future, selling the security could be considered as the best strategy. In this case if an investor does not hold the stock, he can sell in short, which means that he borrows an amount of stocks from the broker and selling it in the market hoping that the prices will go down. Then the investor can buy that amount from the exchange and gives it back to the broker. Thus the difference between the sell price and buy price would be the investor profits or losses.
Since short sellers possess important information and their trades are important accomplishments affecting stock prices efficiency (Boehmer et al., 2007). securities exchanges implemented restricted rules regarding the short selling, in some exchanges short selling is not allowed, while it is permitted in others. Bursa Malaysia allows short selling to certain listed companies. In Bursa Malaysia, trading in regulated short selling is allowed by separate account different from normal trading account. (Ramiah et al., 2008)
Rules of Off-Market Trading
Off-market trading refers to the transaction stocks of listed companies which occur outside a formal securities exchange. Off-market transactions are conducted through negotiation rather than an auction system. The reason for using Off-market trading is usually to transact big block of stock without affecting the stock prices.
Off-Market trading is allowed in Bursa Malaysia which is known as direct business transaction (DTB). It is used to transact between two stock broking companies and/or to transact between two clients within a stock broking company. (Ramiah et al., 2008)
Transaction Costs
Transaction costs are the amount of money spends to buy or sell securities; it could be as explicit transaction fees or implicit, for instance, the market impact cost, the cost of gathering information and the cost of monitoring the firm's activities in an imperfect market. Lowering such costs may attract more traders and increase market efficiency. The explicit transaction costs in Bursa Malaysia are fourfold: first, the brokerage fees which is payable by both buyer and seller, will be the minimum prescribed or on a fully negotiated basis between the broker and its clients, subject to a maximum of 0.70% of the contract value, whichever is higher. Table 2.8 shows the minimum brokerage rates.
Table 2.8 the minimum brokerage rate of trading in Bursa Malaysia
Category of Trade
Minimum Brokerage Rate
Inter-broker
Fully negotiable
Institutional
Fully negotiable
Retail trades valued above RM100,000
0.3% of contract value
Retail trades valued below RM100,000
0.6% of contract value
Online routed retail trades
Fully negotiable
Trades executed less than a board lot
Fully negotiable
Trades where cash upfront has been given prior to the execution of the trades
Fully negotiable
Same day buy and sell trades
0.15% of contract value
Second, the clearing fees are divided into two types, the first one is the novated, which is 0.03% of the transaction value payable by both buyer and seller with a maximum of RM1000.00 per contract, the second one is the direct business, which is 0.03% of the transaction value payable by both buyer and seller with a maximum of RM1000.00 per contract and a minimum of RM10.00. Third, the stamp duty which is RM1.00 for RM1000.00 or fractional part of value of securities payable by both buyer and seller, the stamp duty will be remitted to the maximum of RM200. Fourth, the registration fees which is RM3.00 fee is charged per share certificate and is payable to the company registrar for issuance of new certificates.
Key Changes in Market Microstructure
As a part of Bursa Malaysia, continuous effort to improve the market efficiency, major changes have been taken place in its microstructure in terms of trading mechanism and market regulations during the last two decades. These major changes have been done to increase the liquidity, to enhance informed investing and to reduce the transaction and information costs, The changes covered different aspects of Bursa Malaysia market microstructure, which include the following: implementing of electronic trading and settlement system, reforming of KLSE CI and introducing new indices, revamping the trading regulations, making amendments to the listing requirements, reducing of explicit transaction costs, opening access to foreign investors and listing of foreign companies, and enhancing market transparency (for more details about the key changes in Bursa Malaysia market microstructure from 1990 to 2008 refer to Appendix A) .
Summary
A brief history of Bursa Malaysia is presented in this chapter. The current chapter has discussed the trading mechanism in terms of market type, price discovery, order forms and degree of transparency and trading regulations currently implemented in Bursa Malaysia to operate the trading of securities, in detail, as well as presented the key changes in Bursa Malaysia market microstructure regarding trading mechanism and regulation for the period of last two decades.
