China stock market

Stock market regulators in China must fine-tune circuit breaker to avoid repeat of ‘Black Monday’

Allowing market forces to play a bigger role would result in less volatility and greater confidence among retail investors

PUBLISHED : Wednesday, 06 January, 2016, 3:50am
UPDATED : Wednesday, 06 January, 2016, 3:50am

China’s regulators exert a firm control over many things, but the stock market is not one of them. The first day of trading in the new year was labelled “Black Monday”, thanks in no small part to the newly launched circuit breaker, which halted trading in Shenzhen and Shanghai shortly after midday. The disruption has been an embarrassing hiccup for officials.

READ MORE: China’s internet users see dark humour amid stock market rout on first trading day of 2016

The market rout hit not only mainland punters, but Hong Kong investors as well. Coupled with news of another contraction in the country’s manufacturing sector, the ripple effect was felt by markets around the world. The fiasco is a good example of why Beijing needs to allow market forces to work rather than tightening control.

Ostensibly introduced to calm panic trading and to avoid the placing of careless “fat finger” trade orders, the new circuit breaker resulted in even more selling on Monday by nervous mainland investors before the session was suspended. Under the system, the trading of stocks, index futures and options will be suspended for 15 minutes when the CSI 300 Index falls or rises by more than 5 per cent, with trading halted for the rest of the session if it moves by 7 per cent. The index tracks large-cap stocks in Shanghai and Shenzhen.

Stockbrokers have warned of more volatility ahead as the new system kicks in, while a six-month ban on selling by major stockholders of A-share companies will be lifted on Friday. Blocking sales often encourages panic to build up until it spills over into the next trading session. The circuit breaker on the mainland is more stringent than those applied overseas such as in the United States, South Korea and India.

READ MORE: Black debut as China markets suspend business after 7 per cent fall triggers circuit breaker on first trading day of 2016

Given the ease with which it may be triggered, mainland finance officials could face more embarrassing market disruptions in the weeks and months ahead. Circuit breakers make sense in a market like the US, where algorithmic or computer trading dominates and has been blamed for increasing volatility and causing the “flash crash” in May 2010. But they are not so well suited to a market like China’s, where most traders are still retail investors. On Monday, while the northbound trade under the Shanghai-Hong Kong Stock Connect scheme was suspended, southbound trade was deluged by panic selling, thereby contributing to the plunge in the local market.

Black Monday is more than a teething problem. Officials may need to revamp the system. In the meantime, China and its investors need to be ready to pay a painful price as the country’s financial markets adapt to international practices and standards.