Mainland exchanges can learn lessons from HK’s smooth circuit breaker launch
After January’s fiasco, Shanghai and Shenzhen cannot afford to delay the introduction of a sensible system to safeguard against volatile markets
Chinese investors are still feeling the bruises of the country’s January circuit breaker fiasco, and officials should certainly not be considering any relaunch without doing what their Hong Kong counterparts did before they launched its own system, on Monday – listen to what the market wants.
As an old Chinese saying goes: “Once bitten by a snake, expect to be frightened by a coiled up rope for many years.”
The meltdown in the Chinese stock markets triggered by the mainland’s poorly designed circuit breaker has certainly proved damaging, leading to a 22.7 per cent slump in Shanghai stocks since the start of the year, and a 29 per cent fall in Shenzhen.
The mainland circuit breaker was to have been triggered after the CSI300, which track large caps listed in Shanghai and Shenzhen, fell by 5 per cent. That would prompt the market to be suspended from trading for 15 minutes. It would be suspended for the rest of the trading day if the index fell to 7 per cent.
The short-lived circuit breaker cut trading to just half a day on its debut in Shanghai and Shenzhen on January 4, and the two markets traded for just 13 minutes before it was triggered again on January 7.
The Chinese regulator then scrapped the system, after having it in place just four days.
There has been no mention of any resumption – hardly surprising given the mess it caused, the scars of which are still healing.
Hong Kong’s smooth launch on Monday, however, shows just how successfully a circuit breaker can work if designed well.
But China cannot afford to delay a further, more careful plan.
Almost all major stock markets, including the US, London, Australia, Singapore, South Korea, Taiwan and now Hong Kong, have a circuit breaker system in place.
Circuit breakers are among the G20’s recommendations, and the International Organisation of Securities Commissions has issued guidelines on implementing control mechanisms to deal with systemic risk arising from volatile market situations.
Such a system is also vital to guard against damage caused by so-called “fat-finger” errors.
Beijing gave the green light last week to the new cross-border trading link between Hong Kong and Shenzhen, a system which officials hope will be up and running before Christmas. The Stock Connect link between Hong Kong and Shanghai was launched in November 2014.
But China should now consider following Hong Kong’s lead, by introducing a circuit breaker to cover key constituent stocks – in the case of the Hang Seng Index or Hang Seng China Enterprise Index, that’s 81 shares – which can be suspended for five minutes, if they move up and down by 10 per cent in five minutes.
This would prevent any potential repeat of the mess experienced by the Chinese markets in January, which has been blamed by many commentators on too low a threshold. It’s five per cent index movement was the lowest threshold worldwide.
In the US, 15-minute suspensions only happen if shares drop 7 to 13 per cent, and the whole market would only close for the rest of the day if it dropped 20 per cent.
China could also follow Hong Kong by only suspending individual stocks, not the whole market.
The Hong Kong circuit breaker was proposed in a consultation held in January 2015, which collected 381 submission from international trading houses such as BNP, JPMorgan, the majority of whom supported any move to reduce market volatility.
Views among 200 local retail investors were more mixed. Some suggested the breaker should just be on smaller stocks only, more generally prone to wild swings.
HKEX said it eventually chose the breaker for blue chips first, set at a lower threshold, to prevent too many suspensions before possibly expanding the system further in future.
China also held a consultation on its plans for a circuit breaker before its launch in January, but it was generally accepted the regulator had already decided to go ahead with the plans regardless.
Maybe next time around, it might be more sensible to actually listen to what the market thinks.