China charges up circuit breakers to calm stocks
China has sought yet more intervention to heal its wounded stock market, with the Shanghai, Shenzhen and futures bourses mooting the idea of new circuit breakers that would suspend trading of shares altogether if certain thresholds are breached. But market watchers are divided over whether the move would be a blessing or spell more trouble, writes John Loh.
The country’s stock exchanges released a consultation on September 7 requesting feedback for a circuit breaker mechanism that would kick in if the CSI 300 index, which tracks 300 A-shares traded in Shanghai and Shenzhen, experiences huge swings.
Under the proposed plan, trading for all securities on the three exchanges will be halted for 30 minutes if the CSI 300 rises or falls by 5%. In addition, trading will be suspended for the entire day if the index moves by 5% after 2.30pm, or by 7% at any time during the day.
The stock exchanges pointed out that having two triggers was important since a 30 minute suspension would give investors enough time to “cool down” and mull over their investment decisions. A-shares are already subject to a daily up and down limit of 10%. Trading can still continue after that, but only for a reverse order.
China’s latest proposal adds to the repertoire of government rescue efforts put in place since its equities market went violently off the rails in July. Measures have included freezing IPOs, clamping down on short-selling and televised confessions by financial journalists. China’s surprise devaluation of the renminbi last month also fanned fears of a slowdown.
The new circuit breakers appeared to be just what the doctor ordered, coming as global stock markets soared on Tuesday and Wednesday and reversing several weeks of hair-pulling declines, amid news that China would be unleashing more economic stimuli.
That rally proved short-lived, however. As GlobalCapital Asia went to press on Thursday, Shanghai’s benchmark index lost 1.40%, and Hong Kong’s Hang Seng 2.57%. The Hang Seng China Enterprises Index, which tracks H-Shares listed in Hong Kong, was down 1.96%.
Good or bad?
Ivan Shi, senior manager for research with Z-Ben Advisors in Shanghai, reckons the changes, if implemented as they are spelled out in the consultation, could potentially usher in big changes for the way the Chinese stock market functions.
“It could go either way,” he said. “There’s a chance it could lead to more volatility in the markets, but reduce price swings when markets are stressed. If these rules had been in place over the past 10 years they would have been used a lot in 2008 and 2013.”
A market watcher in China thinks the 5% and 7% thresholds are too punitive, as all trading would have to be halted. Differing volatility levels and investor appetite in Shanghai and Shenzhen also mean a uniform circuit breaker is undesirable, he said.
According to a strategist with a Chinese brokerage in Hong Kong, an index-linked circuit breaker was unnecessary. “It’s too much,” he said. “Before this if a stock hits the daily trading limit of 10%, then it affected that stock alone. Now we could have trading frozen for the whole bourse.”
Such a tough stance illustrates the lengths to which China’s regulators will go. With IPOs dead in the water, circuit breakers will only serve to hurt trading volumes, the strategist reckoned. Instead, China should seek to strike a balance between financial stability and long-term reform.
“They’ve done plenty, but we also need a functioning market. It’s oversold, but for a rebound to gain momentum we need stability and liquidity. Right now we have neither.”
But if China goes ahead it would be in keeping with stock exchanges in developed markets as well as the region. The US has a market-wide circuit breaker which allows for trading to be either halted temporarily or closed before the end of the normal trading session, in a bid to contain any outbursts of volatility.
In Asia, the Singapore Exchange introduced a 10% circuit breaker in February last year, while South Korea in June increased its daily stock price movement limit from 15% to 30%. As for India, circuit breakers are triggered when stocks swing 10%, 15% and 20%.
The proposal for a circuit breaker comes at a time when A-shares have tumbled to a level some analysts see as attractive.
An equity researcher with a foreign bank estimated that Chinese shares, excluding banks, were trading at an average 30x P/E, but large-cap stocks were looking reasonable. Valuations for the CSI 300 meanwhile were even more palatable at just 13x P/E.
But while a market-wide circuit breaker could be a boon for retail investors, it will disrupt trading operations and settlement for institutional investors, according to Arthur Kwong, head of Asia Pacific equities at BNP Paribas Investment Partners.
“Say we execute a trade and are halfway through clearing when the market shuts down. It’ll be left hanging until the next day. In a volatile market, that exposes us to a lot of risk until trading resumes again. As fund managers, we need to be able to position ourselves over a whole trading day.”
But for others, this kind of intervention is just what the market needs.
The mechanism provides a “cooling-off period” when the market experiences fierce fluctuations, said Yang TieCheng, a partner with Clifford Chance in Beijing. He reckons it would help guard against an irrational volatility, especially in light of the recent crash.
“Compared with other initiatives adopted by the regulators this week, such as the tax preference policies encouraging long-term shareholding, the circuit breaker may work more directly and visibly on the markets,” he said, adding that its impact would have to be seen over time.
This transparency will be necessary as foreign institutions have become increasingly hesitant to put money into China because of the multiple rounds of intervention, said the market observer. The question now was whether more intervention would be the key to restore confidence.
“What good is it if China is a great investment, but at a moment’s notice the government can come in and change the rules, and investors can’t get their money out?” he said.
The consultation on circuit breakers is open for public feedback until September 21.