After two distressing sessions that tripped the breaker and shock global markets, the China Securities Regulatory Commission (CSRC) decided to suspend the rule arguing it was exacerbating market declines and increasing market volatility. Why did the Chinese circuit breakers failed to attempt their objectives? What are the fundamental differences with the U.S. ones?
Nicholas Brady, the ex-US treasury secretary who set up the circuit breakers on US stock markets, in an interview with Nick Baker, explained the reasons why China was “on the wrong track” with its current circuit breakers. According to him, Chinese breaker system seemed to be poorly designed with both too-low and too-close thresholds. He argued how thresholds must have been set in a way that appropriately reflected the market. For instance, a 7 per cent loss in the U.S. market is really rare (expect for 1987, the Great Depression, and 2008, the financial crisis). On the contrary, in 2015, it happened seven times in China. Setting 7 per cent as a threshold below which the market shut down was definitely a mistake. Moreover, the fact that the two breakpoints were so close to each other ended to create much more panic in investors after the first threshold had been reached. The right thing to do was to widen the band: in the U.S., the second breakpoint is 3 times higher than the Chinese ones and the U.S. market is even less volatile.
A similar viewpoint is the ones of Chris Weston, chief markets strategist at IG Markets in Melbourne. According to him “[…] the distance between the initial 5% circuit break (the 15 minute window) and the full halt of the market at 7% is just way too narrow […] when the market hits 3.5% to 4% we see everyone panic and put in their sell orders […] the distance between the two needs to be wider otherwise we are going to see this happen time and time again. I would look at a full halt at 9-10% (Colgan, 2016)”.
Even stronger is the critique moved by David Dai, Shanghai-based investor director at Nanhai Fund Management Co. He strongly criticised both CSRC decisions of introducing circuit breakers and fixing the first breakpoint at 5 per cent. Firstly, he argued how markets should be free to find their own equilibrium on their own, without any external constraints or limitations. According to him the circuit breakers mechanism strongly deepened investor panic and without it the market wouldn't have dropped so much. Secondly, he explained how a threshold of 5 per cent for the Chinese market was too low: since last June, if the breakpoints had been in place earlier, the circuit breaker would have been activated more than 20 times (Seeney, 2016).
What are the consequences?
On Thursday 7th, markets opened lower pretty much everywhere: the UK's FTSE 100 was down 2.75 per cent to 5906 points, the French CAC was down 2.5 per cent and the German DAX was down 3.1 per cent (Sheffield, 2016).
The flip-flop in the circuit breaker rule added to the sentiment among global investors that Chinese authorities are improvising (and improvising poorly) to stabilize markets and support the national economy. The U-turn on circuit breakers was just another element, after the interest-rate cuts, the currency interventions and stock market reforms over the past year, that failed to restore the international confidence in Chinese markets (Wearden, 2016).
Maarten-Jan Bakkum, a senior strategist at NN Investment Partners, in an interview for Bloomberg complained about Chinese regulators “They are changing the rules all the time now […] the risks seem to have increased” (News, 2016). Uncertainty related to China’s economic future and regulation dominated many talks at the World Economic Forum in Davos. The events that took place in the first week of 2016 and the abnormal stock market volatility have demonstrated how China is still characterized by an immature market, inexperienced investors, an imperfect trading system and inappropriate supervision mechanisms (Yao, 2016). Christine Lagarde, managing director of the International Monetary Fund, on the trouble China has had in telling investors how it intends to manage financial markets, claimed how there have been numerous communication issues and problems that must be solved to restore confidence in investors and to relaunch the Chinese economy (Euler, 2016). The US Treasury Secretary Jack Lew when interviewed on China's promise to make its markets more open and reform its economy questioned if the Government is actually prepared to follow through on an agenda they charted out (Euler, 2016). He argued how words and plans are not sufficient anymore. Facts are needed. After the fiasco in June-August and the ones with circuit breakers, Mr Xiao Gang, CSRC’s chairman, needs to face an important challenge: restore trust in investors.
To conclude, what is the answer to McGee initial question: the Chinese circuit breakers is dead or simply suspended? Everyone agrees the mechanism should be scrapped, or at least modified. The CSRC did not give an indication how long the suspension would last, but no one thinks the circuit breaker will come back in its present form (Chang, 2016). We think a new circuit breaker will undoubtedly come back improved: for instance, it will be extended to other stocks than the ones of the CSI 300 in order to incorporate a wider trading range. Other suggestions came from Brett McGonegal of Reorient Group who argued how the limit should be 15% instead of 7% and suggested how the trigger should not be “price based” but “volume based.” In this way, limits breached in thin trading would be ignored and the overall market volatility would be more controlled (Chang, 2016). And this is the purpose of circuit breakers.
Giorgia Bulgarelli
Nicholas Brady, the ex-US treasury secretary who set up the circuit breakers on US stock markets, in an interview with Nick Baker, explained the reasons why China was “on the wrong track” with its current circuit breakers. According to him, Chinese breaker system seemed to be poorly designed with both too-low and too-close thresholds. He argued how thresholds must have been set in a way that appropriately reflected the market. For instance, a 7 per cent loss in the U.S. market is really rare (expect for 1987, the Great Depression, and 2008, the financial crisis). On the contrary, in 2015, it happened seven times in China. Setting 7 per cent as a threshold below which the market shut down was definitely a mistake. Moreover, the fact that the two breakpoints were so close to each other ended to create much more panic in investors after the first threshold had been reached. The right thing to do was to widen the band: in the U.S., the second breakpoint is 3 times higher than the Chinese ones and the U.S. market is even less volatile.
A similar viewpoint is the ones of Chris Weston, chief markets strategist at IG Markets in Melbourne. According to him “[…] the distance between the initial 5% circuit break (the 15 minute window) and the full halt of the market at 7% is just way too narrow […] when the market hits 3.5% to 4% we see everyone panic and put in their sell orders […] the distance between the two needs to be wider otherwise we are going to see this happen time and time again. I would look at a full halt at 9-10% (Colgan, 2016)”.
Even stronger is the critique moved by David Dai, Shanghai-based investor director at Nanhai Fund Management Co. He strongly criticised both CSRC decisions of introducing circuit breakers and fixing the first breakpoint at 5 per cent. Firstly, he argued how markets should be free to find their own equilibrium on their own, without any external constraints or limitations. According to him the circuit breakers mechanism strongly deepened investor panic and without it the market wouldn't have dropped so much. Secondly, he explained how a threshold of 5 per cent for the Chinese market was too low: since last June, if the breakpoints had been in place earlier, the circuit breaker would have been activated more than 20 times (Seeney, 2016).
What are the consequences?
On Thursday 7th, markets opened lower pretty much everywhere: the UK's FTSE 100 was down 2.75 per cent to 5906 points, the French CAC was down 2.5 per cent and the German DAX was down 3.1 per cent (Sheffield, 2016).
The flip-flop in the circuit breaker rule added to the sentiment among global investors that Chinese authorities are improvising (and improvising poorly) to stabilize markets and support the national economy. The U-turn on circuit breakers was just another element, after the interest-rate cuts, the currency interventions and stock market reforms over the past year, that failed to restore the international confidence in Chinese markets (Wearden, 2016).
Maarten-Jan Bakkum, a senior strategist at NN Investment Partners, in an interview for Bloomberg complained about Chinese regulators “They are changing the rules all the time now […] the risks seem to have increased” (News, 2016). Uncertainty related to China’s economic future and regulation dominated many talks at the World Economic Forum in Davos. The events that took place in the first week of 2016 and the abnormal stock market volatility have demonstrated how China is still characterized by an immature market, inexperienced investors, an imperfect trading system and inappropriate supervision mechanisms (Yao, 2016). Christine Lagarde, managing director of the International Monetary Fund, on the trouble China has had in telling investors how it intends to manage financial markets, claimed how there have been numerous communication issues and problems that must be solved to restore confidence in investors and to relaunch the Chinese economy (Euler, 2016). The US Treasury Secretary Jack Lew when interviewed on China's promise to make its markets more open and reform its economy questioned if the Government is actually prepared to follow through on an agenda they charted out (Euler, 2016). He argued how words and plans are not sufficient anymore. Facts are needed. After the fiasco in June-August and the ones with circuit breakers, Mr Xiao Gang, CSRC’s chairman, needs to face an important challenge: restore trust in investors.
To conclude, what is the answer to McGee initial question: the Chinese circuit breakers is dead or simply suspended? Everyone agrees the mechanism should be scrapped, or at least modified. The CSRC did not give an indication how long the suspension would last, but no one thinks the circuit breaker will come back in its present form (Chang, 2016). We think a new circuit breaker will undoubtedly come back improved: for instance, it will be extended to other stocks than the ones of the CSI 300 in order to incorporate a wider trading range. Other suggestions came from Brett McGonegal of Reorient Group who argued how the limit should be 15% instead of 7% and suggested how the trigger should not be “price based” but “volume based.” In this way, limits breached in thin trading would be ignored and the overall market volatility would be more controlled (Chang, 2016). And this is the purpose of circuit breakers.
Giorgia Bulgarelli