China scraps its broken stock market circuit breaker

China's Transition
China's Transition

Updated 9:58am ET

China’s new circuit breaker shut down its volatile stock markets on Jan. 7—the second time in one week. Though the two-part mechanism—introduced on Jan. 4 and put to immediate use—was meant to tame drastic fluctuations, critics say it made investors panic instead.

At 10:30pm local time (9:30 pm ET) on Jan. 7, the China Securities Regulatory Commission announced on Weibo that it was suspending the circuit breaker rule.

The rule halted trading for 15 minutes after a 5% drop in the CSI 300 index (a benchmark of the largest 300 stocks listed in Shanghai and Shenzhen) and then halted them for the rest of the day after a 7% retreat. In both instances this week, a first pause was quickly followed by trading being shut down. (Jan. 7 was China’s shortest trading day ever.)

A similar circuit breaker exists in the US, but with much wider gaps: It temporarily halts trading after a 7% drop in the Standard & Poor’s 500 Index, then again at 13%—but suspends trading for the day only if losses reach 20%.

In China’s volatile market, where a 5% drop or jump isn’t uncommon in a normal trading day, all that a 5% pause period does when the market falls is “create a time when everyone can get their sell orders in,” Christopher Balding, an economics professor at Peking University HSBC Business School, told Quartz.

And then, when the market drops by 7% and is shut for the day, investors “wake up the next morning and think ‘I have got to take my money out,'” Balding said. “It ramps up the panic mentality.” Most market experts agree circuit breakers should just be used in “extraordinary circumstances.”

The 5% and 7% stops have “a ‘magnet effect’ as prices gravitate towards the breaker, and prompt a stampede that drains market liquidity,” wrote Hao Hong, chief China strategist at Bocom International Holdings in a report cited by Bloomberg.

And there are early signs Thursday that China’s down markets could spark investors around the world to sell: Britain’s FTSE 100 index was down as much as 3% in early trading, and Germany’s DAX Index had dropped 3.5%.

The circuit breaker is just the latest example of Beijing’s heavy-handed attempts to control the stock markets, efforts that cost the government and state-owned enterprises over $1 trillion last year. Chinese regulators don’t seem to understand “what markets are, how they work or how they are going to react,” Balding said.

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