China will launch a stock market circuit breaker mechanism at the beginning of next year, the latest move to stamp out wild swings in the country’s volatile stock market.
A move of 5% in either director on the CSI 300 Index, China’s blue-chip tracker, would trigger a 15-minute halt for stocks, convertible bonds, stock options and futures contracts, according to a statement jointly issued by the Shanghai and Shenzhen Stock Exchanges and the China Financial Futures Exchange late on Friday. A swing of 7% would freeze trading for the rest of the day.
The CSI 300 Index tracks 300 stocks with the largest market capitalizations listed on the Shanghai and Shenzhen bourses. Currently, Chinese individual stocks are only allowed to rise or sink by 10%, the maximum daily limit.
“As the CSI 300 Index reflects the overall market performance of Shanghai and Shenzhen bourses, when it moves up or down by 7%, it means there is extreme volatility and the market might face systematic risks,” said the statement.
In the past year, China’s stock market has become one of the most volatile indices in the world, with shares advancing as much as 150% in a year-long rally running through mid-June, before plunging 43% to a low in late August.
Deng Ge, a spokesman at the China Securities Regulatory Commission, said at a briefing on Friday that the introduction of a circuit-breaker mechanism can offer a “cooling-period” when there are sharp fluctuations in the market.
“That [in return] can help maintain market stability and order, and protect investors’ interests.,” he said.
The new rules, which will come into effect on January 1, were first proposed in September in the wake of the summer’s market rout. The securities regulator’s recent approval represents Beijing’s latest effort to stabilize the stock markets and reduce excessive volatility.
Unlike in developed markets, unsophisticated retail investors account for the majority of trading in China – roughly 90% in the A-share markets, according to State Street Global Advisors.
The country’s approximately 200 million retail investors, however, trade more frequently than any other investors. 81% of them trade at least once a month, the highest percentage of any country in the world, compared with 53% in the US and 73% in Hong Kong, according to a survey by State Street last year.
Meanwhile, 72% of Chinese adults are found to be financially illiterate (they don’t adequately understand key monetary ideas including risk diversification, inflation and compound interest), slightly lower than Asia’s average of 73% but higher than the world’s average of 67%, according to a recent study conducted by Standard & Poor’s.
“The dominance of retail investors in the A-share market makes [it] easier to speculate the stocks and produce the ‘sheep-flock’ effect,” Xu Gao, chief strategic at Everbright Securities, said in a note on Friday. “The extreme volatility over the summer well showcased the market system’s loopholes for maintaining stability.”
According to some equity analysts, market-based breakers appear to be a logical market reform move and would be better accepted by investors than arbitrary state interventions that seemed to dent China’s commitment to the rigours of market discipline.
Analysts at Haitong Securities said that, although it cannot fundamentally solve the problem of extreme market volatility - primarily caused by the amplification of leveraged financing, proliferation of financial derivatives and the propagative panic among investors - it could well deal with market emergencies, such as huge sell-offs. “It is a necessity for mature markets.”
Friday’s announcement also follows an raft of recent measures by Beijing to loosen its grip over the market after it introduced a series of controversial measures to rescue the market in summer.
Last month, it resumed initial public offerings following a four-month ban and scrapped a five-month rule requiring domestic brokerages to hold daily net long positions in their propriety trading accounts as the county’s shares continue to stabilise.
The benchmark Shanghai Composite Index is now up more than 20% from its August lows.
Circuit breakers are a common practice in other developed markets. For example, the US set up a market-wide mechanism after the 1987 crash. A 7% drop in the S&P 500 Index would trigger a 15-minute halt for stocks listed on the New York Stock Exchange and Nasdaq Stock Market.