The dramatic Hong Kong stock market fall on Wednesday, when the benchmark indicator staged a roller-coaster ride ending with the biggest single-day decline since 2008 by shedding nearly 6 percent, was taken in its stride by investors, the stock exchange and regulatory agencies.

Calm returned the following day with the stability of the market once again affirmed by the underlying strength of the well-tested system upheld by the venerable institutions in banking, investment and broking. The integrity of the system is further augmented by the high level of transparency in corporate governance and price discovery under the watchful eye of the Securities and Futures Commission (SFC).

That solid foundation of Hong Kong's capital market was laid in the 1970s after the merger of the four stock exchanges. Since then, its ability to withstand shocks has been tested many times. The lesson learned in each of these stress tests was taken to heart by the institutions to help improve their capabilities in crisis management. This is without the need to seek government intervention, which is anathema to free market principles.

The Hong Kong stock exchange developed into its present form after the government modernized and reformed the market after the large 1973 crash. Other than merging the various exchanges into one monopoly, the government also drafted a new securities ordinance and established a watchdog agency, which in its infancy, lacked the necessary legal authority to do its job properly.

Of course, the SFC has grown in power and capability since then. But in the early days, it was seen to be a toothless tiger while unscrupulous traders and corporate raiders ran rings around it with impunity.

The biggest test to the free market system was posed by a tornado of panic selling triggered by a breakdown in confidence in Hong Kong's political future. In an unprecedented move, the stock exchange closed its doors in October 1987 for four trading days, igniting a storm of protest from local and foreign investors.

The stock exchange's rash decision was seen to have undermined Hong Kong's bid to be an international financial center in the region in competition with Singapore. It was a lesson the stock exchange can never forget and a mistake it vowed never to repeat.

The only time the government found it had no other choice but to intervene directly in the market was in 1997 when foreign hedge funds wreaked havoc in the capital market by creating a credit crunch through attacks on the currency. To counter the hedge funds' ploy of profiteering from shorting index futures, the Hong Kong Government bought HK$100 billion of shares in one day to prop up prices.

The move, though criticized by purists as contravening free market principles, was widely considered necessary and appropriate.

Since then, the government has, on numerous occasions, reviewed and strengthened the securities ordinance and, more importantly, revamped the listing rules to ensure greater transparency and fairness to all shareholders.

Hong Kong has yet to face a crisis that would fundamentally challenge the integrity of its capital markets. The system behind it works.

(HK Edition 07/10/2015 page6)