Hong Kong needs to switch on circuit breakers
The stomach-churning movements recently seen in three Hong Kong-listed stocks, where billions of dollars were wiped out in a span of a few hours, have shone a light on the lack of protection in Hong Kong against such rapid fluctuations. The city needs to embrace circuit breakers urgently if it wants to bolster its defences.
For much of the past two weeks, the stocks of Hanergy Thin Film Power Group, Goldin Properties and Goldin Financial have been grabbing a lot of attention — but for all the wrong reasons.
Hanergy, which has gained about 245% in the past year, crashed spectacularly on May 20, tumbling 47% and losing almost $19bn of its market capitalisation. Meanwhile, the property arm of Goldin dropped 41% on May 21, while the financial division lost 43% the same day — all for no very clear reason.
Sure, both the Goldin units recouped some of their losses the following day, but just the fact that the share prices saw such unexpected wild swings should act as a big red flag for the Hong Kong market and its regulator.
At the very least, the case for circuit breakers looks stronger than ever. The mechanism limits how far a stock can rise or fall during a short space of time. If the stock goes beyond these pre-set boundaries, trading can be halted — giving investors time to take a breather and make informed decisions about the stock.
Hong Kong Exchanges and Clearing Limited (HKEx) has not put the tool in place despite discussions in recent years. Concerns have been raised that circuit breakers might result in too much market intervention. But the incidents of the last few weeks have made it clear that the stock market is in dire need of this kind of support.
Let’s be clear, Hong Kong is hardly at the vanguard of this development. The US Securities and Exchange Commission first put breakers into place in the late 1980s in a bid to reduce volatility and promote investor confidence. Called limit-up limit-down, price bands are set at 5%, 10% and 20% above and below the average price of the stock over the immediately preceding five-minute trading period.
The US also has a market-wide circuit breaker, which is triggered when markets drop to such an extent that there is a fear that liquidity would be exhausted. In these circumstances, trading may either be halted temporarily or the markets might close before the end of the normal trading session.
Other Asian markets have also realised the benefits of the safety net. The Singapore Exchange introduced a 10% circuit breaker in February last year for stocks in the Straits Times Index and the MSCI Singapore Index. It had learned its lesson the hard way, though, only putting this structure in place following a collapse of penny stocks in October 2013 that which wiped out almost $6bn from their collective value.
South Korea, meanwhile, will increase its daily stock price movement limit from 15% to 30% from June 15 to boost trading on the exchange — having had limits in place from before 1995. But to continue to protect investors, it will implement more stringent market monitoring criteria to prevent unfair trading.
Mainland China, too, has tight control on gains and falls, limiting fluctuations to a maximum of 10% a day, while Indian breakers are triggered at 10%, 15% and 20% levels.
So, for the Hong Kong exchange, which has soared since April and is expected to continue rallying, not having similar protection is a recipe for disaster — especially as the city’s important retail investor base risks getting burnt again if a Hanergy-like situation is repeated. Institutional investors may also start to have second thoughts about investing in Hong Kong if they feel they could get caught up in a crash that no one has any way of stopping.
And the problem is only likely to get worse, given the ballooning activity between Shanghai and Hong Kong that has been driven by the Stock Connect.
If the HKEx wants to avoid a painfully damaging crash in the future, it needs to start building its defences sooner rather than later. Circuit breakers are a tried-and-tested way to protect the market, and Hong Kong should no longer dilly-dally about putting them in place.
The regulator can’t foresee all booms and busts in its financial markets. But there's no shame in preparing for the worst.