Banking & Finance

Short circuit

Circuit breakers prove failure for China’s bourses

Xiao addresses the Asian Financial Forum in Hong Kong

Under pressure: CSRC boss Xiao

‘Crossing the river by feeling the stones’ was Deng Xiaoping’s famous description for how China should inch its way forward during the early economic reforms of the 1980’s.

But what about situations in which safe crossings look impossible? And what happens if the river proves too strong, sweeping away all before it?

Events in China’s stock markets made their regulators look more panicked than pragmatic this week, and may further tarnish the central government’s reputation for competent economic management.

Stock market bosses have been tinkering with the bourses since July last year in an effort to stem the effects of the A-share market’s spectacular meltdown (see WiC295). One of the proposals that came into effect at the beginning of this year was the circuit breaker mechanism. Whenever the CSI300 index, which tracks stock prices for large caps in both Shanghai and Shenzhen, rises or falls by 7% in a single session, trading is automatically stopped for the day.

The new rule saw immediate action on Monday when the A-share market was suspended after dropping 7% in the afternoon session. On Thursday trading was halted even earlier: investors were allowed about 15 minutes of action in the morning as the bourse slumped 7% in rapid time.

A research piece this week from Steven Sun, head of China equity research at HSBC, accepts that “trial and error” has been an important part of China’s reform efforts. But it also describes the new trading rules as “poorly designed”. Intended to prevent wild fluctuations in the market, they seem to have had the opposite effect, stoking the herd-like mentality common to China’s retail investor base.

Under the rules launched on Monday, trading was also suspended for 15 minutes when the index moved by more than 5% on the previous day’s close. But critics say that this only panicked the markets, making further declines (and a full market closure) more likely.

As Sun also points out, the A-share market dropped over 5% intra-day on 33 occasions last year, and moved more than 7% 11 times. That means that the circuit breakers would have been a common occurrence – on about 15% of trading days across the year, in fact.

The CSRC seems to have come to similar conclusions on Thursday night, when it announced that it would shelve the circuit breakers for the foreseeable future, admitting that they hadn’t met expectations in giving investors a “cooling-off” period.

“The circuit-breaker mechanism has a certain ‘magnetic effect’, drawing investors to sell their shares before the circuit breaker is about to activate, thus causing the stock index to fall more rapidly,” the regulators concluded.

The state media went on the defensive, insisting that the lessons of this week’s market chaos would soon be learned. “Next, the CSRC will carefully sum up the experience and lessons, organise research on improving the mechanism and seek extensive public opinion,” Xinhua reassured. “China is still trying to reform the capital markets and refine the rules. It is inevitable that mistakes will be made. It is more important for the authorities to have the courage to right the wrong,” suggested the Beijing News.

But the U-turn soon saw netizens poking fun at exchange bosses. “We should be proud that we have a very efficient government,” one quipped on Sina Finance. “The circuit breaker got the job done [opened and closed the market] in a record time [in less than 15 minutes]. And the CSRC may enter the record book for scrapping a market-moving rule in the shortest time too.”

Others focused on the shorter working hours in Shanghai this week. “Stock broking is such a good profession because when the market goes up, you make loads of money and when the market goes down, you get to go home early,” another wag proposed on weibo.

Analysts expect that the CSRC will move closer to the American system of calling a halt only if the market drops 20%, or shorten the time periods for trading suspensions. But its under-pressure boss Xiao Gang will rue the start to the year. Reuters had earlier speculated that his job was under threat and this week’s turmoil will not make it more secure.

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