Hong Kong’s chance to show mainland markets how circuit breakers are supposed to work
City’s bourse has adopted international best practice in introducing the mechanism to tackle panic trading
Hong Kong’s stock market has become the latest international bourse to introduce circuit breakers. At a time of rising volatility and high-frequency computer trading, the technical breaks aim to avoid panic and restore orderly trading. The jury is still out about how effective such a mechanism is during extreme market conditions, but its short-term effects in calming markets seem to make it worth the effort.
The system put in place is moderate, aiming at a temporary trading halt to individual stocks rather than the whole market. It therefore avoids the inherent problem with the more severe version on the mainland, now scrapped, which led to a market meltdown in January and caused contagion to other markets for a time. Depending on how effective it turns out to be, our new system may serve as an example for mainland regulators in fine-tuning their own system.
Plans for a circuit breaker started in the middle of last year. Overseas examples of panic selling and “flash crashes” caused by so-called fat fingers and high-frequency algorithmic trading had been fresh on the minds of local regulators. Under the new “volatility control mechanism”, the trading of a stock will be stopped temporarily if its price surges or drops by 10 per cent or more within five minutes. Up to two halts may be activated each day for the 81 stocks on the Hang Seng and H shares indexes.
Hong Kong regulators and traders have been haunted by the fiasco with the mainland stock market in January. A new but poorly conceived circuit breaker stopped trading in the entire market for 15 minutes on two days. A subsequent break ended trading for the whole day. The panic first spread across the mainland, then to other global markets. The Shanghai Composite Index tumbled 22.7 per cent, while the Shenzhen Composite Index lost 28 per cent in January. Global markets vapourised
US$2.5 trillion in just one week. The fiasco was a severe loss of face for mainland regulators, who were forced to scrap the circuit breaker just four days after its introduction.
By following similar systems in other major bourses, Hong Kong’s circuit breaker only targets individual stocks rather than the whole market. It therefore has little chance of worsening a market panic the way the mainland system did early this year.
No one can predict the future, but one can safely say the next waves of market volatility are never far off. Our new system will be tested soon. Depending how well it works, the mainland may take it as a practical example.