The role of stamp duty in Hong Kong stock market liquidity

Did you know that every time you trade Hong Kong stocks, you are contributing to one of Hong Kong's most important revenue sources? Hong Kong's stamp duty on securities transactions is not just a tax levy; it is a critical policy instrument that impacts market liquidity, investment decisions, and even Hong Kong's competitiveness as an international financial center. Following a series of reforms in 2023 and 2024, it has never been more essential for investors and market participants to gain a deep understanding of this tax.

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Understanding Hong Kong’s Stamp Duty Regime for Securities

Hong Kong’s stamp duty on securities is one of the oldest continuously operated transaction taxes in the world. Unlike many major financial centers that have abolished such levies, Hong Kong continues to impose an ad valorem stamp duty on stock transfers, which has become a defining characteristic of Hong Kong's market structure and competitive positioning.

This tax is levied at 0.1% on both the buyer and the seller (totaling 0.2%) of the transaction value or market capitalization of Hong Kong stock securities, whichever is higher. The tax applies to all transfers of shares in companies registered in Hong Kong, regardless of the trading venue or the residency of the transacting parties.

Breakdown of Total Transaction Costs

While stamp duty is the largest component of trading costs on Hong Kong Exchanges and Clearing (HKEX), accounting for approximately 90% of all official fees, investors are also subject to other additional levies:

• Securities and Futures Commission (SFC) Transaction Levy: 0.0054% (shared by buyer and seller)
• Financial Reporting Council (FRC) Levy: 0.0003% (shared by buyer and seller)
• HKEX Trading Fee: 0.01% (shared by buyer and seller)
• Hong Kong Securities Clearing Company (HKSCC) Settlement Fee: 0.004% (shared by buyer and seller)

These additional fees total approximately 0.0197%, bringing the total transaction cost under the current tax rate to roughly 0.22% per side, or approximately 0.44% for a complete round-trip trade (buy and sell).

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The Stamp Duty Rollercoaster: A Review of Recent Changes

The 2021 Tax Hike: A Controversial Decision

In February 2021, Financial Secretary Paul Chan announced a 30% increase in the stamp duty rate, raising it from 0.1% on each of the buyer and seller (0.2% in total) to 0.13% on each side (0.26% in total). This marked the first hike in nearly three decades and took effect on August 1, 2021.

The government's rationale centered on revenue generation, projecting an additional HK$12.9 billion annually in stamp duty revenue. The pandemic-induced economic downturn had severely impacted government finances, and given the HKEX's record performance in 2020, securities stamp duty presented an enticing source of revenue.

The Actual Impact of the 2021 Tax Hike

Market data shows that trading volume declined significantly following the stamp duty increase:

2023 Course Correction: Restoring Competitiveness

To revitalize Hong Kong's stock market, Chief Executive John Lee announced in his October 2023 Policy Address that stamp duty rates would be restored to pre-2021 levels. The Stamp Duty (Amendment) (Stock Transfers) Bill 2023 was gazetted on October 25, 2023, and the rate reduction to 0.1% for both buyers and sellers took effect on November 17, 2023.

2024 Reforms: Targeted Exemptions

Building on the 2023 tax cut, the Hong Kong Government passed the Stamp Duty Legislation (Miscellaneous Amendments) Bill 2024 on December 11, 2024, with the relevant provisions coming into effect on December 21, 2024. This legislation introduced two key exemptions:

• Real Estate Investment Trust (REIT) Stamp Duty Exemption: Exempts the 0.1% stamp duty (per side) on transfers of REIT shares or units, aligning Hong Kong with international practices in markets such as the US, Singapore, Japan, and Mainland China.
• Options Market Maker Exemption: Exempts options market makers conducting market making activities from the HK$5 fixed stamp duty on contract notes, putting them on par with market makers in other products who already enjoy stamp duty exemptions.

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How Transaction Taxes Affect Market Liquidity

Impact on Trading Volume

Academic research consistently shows that securities transaction taxes reduce trading volume. A comprehensive 2011 study by the International Monetary Fund (IMF) found that the elasticity of stock market trading volume with respect to transaction costs typically ranges between -0.5 and -1.7. This means that for every 1% increase in transaction costs, trading volume typically decreases by 0.5% to 1.7%.

These elasticities suggest that, purely from a transaction cost perspective, Hong Kong's 30% stamp duty increase in 2021 was expected to reduce trading volume by approximately 15% to 51%, although other factors complicate direct comparisons.

Impact on Market Liquidity

A reduction in trading volume directly affects market liquidity. As the IMF study pointed out: "Because STTs make some transactions unprofitable, they reduce volume. This will also typically reduce liquidity, the price impact of a given transaction."

The Market Maker Problem: A particular concern in Hong Kong was that, unlike taxes in other markets, its stamp duty did not distinguish between liquidity providers (market makers) and liquidity takers. This meant that market makers providing vital liquidity services faced the same transaction costs as other traders. The 2024 exemptions for options market makers and REIT transfers recognized this concern and marked a move toward a more refined transaction tax design.

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Hong Kong in a Global Perspective

Examining how other major financial centers handle securities transaction taxes provides essential context for evaluating Hong Kong's stamp duty policy.

Global Trend Toward Abolition

The international trend over the past few decades has been to reduce or abolish securities transaction taxes:

• Japan abolished turnover taxes on stock transactions in the late 1990s to revitalize its sluggish stock market.
• Australia abolished federal stamp duty on share transfers in 2001.
• Italy substantially cut capital and transaction taxes in 2000.
• France abolished its share transaction tax in 2009, although it reintroduced a modified version in 2012.

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Revenue Considerations and Fiscal Trade-offs

Stamp Duty as a Revenue Source

Securities stamp duty is an important component of Hong Kong's tax revenue:

• FY 2021-2022: Securities stamp duty revenue reached HK$65.9 billion
• Share of Total Tax Revenue: 15.4%
• Share of Gross Domestic Product (GDP): 2.3%

The Laffer Curve Effect

The experience from 2021 to 2023 provides a compelling case study in transaction tax dynamics. Although the government projected that raising the stamp duty rate by 30% would generate an additional HK$12.9 billion in annual revenue, the actual outcome differed significantly due to a sharp drop in trading volume.

As average daily turnover plunged from HK$188.5 billion (1H 2021) to HK$115.0 billion (1H 2023)—a decline of 39%—the revenue gains from the higher tax rate were partially or even entirely offset by the diminished trading volume. This classic "Laffer Curve" dynamic demonstrates that an optimal transaction tax rate exists, beyond which higher rates actually reduce revenue.

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Impact on Different Market Participants

Stamp duty impacts different types of traders unevenly:

• High-Frequency Traders: Most severely affected due to slim profit margins per trade; a total round-trip cost of 0.44% renders many short-term trading strategies unprofitable.
• Long-Term Investors: Least affected, as transaction costs are amortized over extended holding periods; 0.2% each for entry and exit represents a modest overall cost for multi-year investments.
• Market Makers: Historically placed at a disadvantage compared to jurisdictions with market maker exemptions; the 2024 options market maker exemption has partially addressed this issue.
• Retail Investors: Bear relatively high effective costs when combined with brokerage commissions and platform fees.
• Institutional Investors: Face substantial absolute stamp duty costs on block trades, which can impede portfolio rebalancing.

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Future Outlook and Policy Implications

Task Force on Promoting Stock Market Liquidity

Recognizing the decline in market liquidity as a critical challenge, the Hong Kong Government established the "Task Force on Promoting Stock Market Liquidity." The stamp duty reduction in November 2023 and the targeted exemptions in December 2024 represent the implementation of the Task Force's recommendations.

Potential Further Reforms

Several policy options are worth considering to further enhance Hong Kong's market competitiveness:

• Further Rate Cuts: Following the examples of Japan, Australia, and Singapore to gradually reduce stamp duty to near or zero.
• Expanding Market Maker Exemptions: Extending the options market maker exemption to all designated market makers to bolster liquidity provision.

Hong Kong's stamp duty journey—from the controversial hike in 2021, to the course correction in 2023, and the targeted exemptions in 2024—illustrates the delicate balance between fiscal policy and market competitiveness. As regional competition intensifies, particularly from Singapore and Mainland China, how Hong Kong approaches transaction costs will continue to shape its standing as a leading international financial center. For investors, understanding these dynamics is essential for navigating the market effectively and anticipating future policy shifts.