China to Introduce Circuit Breaker Mechanism in Efforts to Check Price Abnormalities in the Capital Market

China to Introduce Circuit Breaker Mechanism in Efforts to Check Price Abnormalities in the Capital MarketChina is planning to implement a circuit breaker mechanism in its bourses starting next year as part of their efforts in checking abnormalities in the price in the capital market. Based on the rules announced by the Chinese bourses, trading of stocks, options and index futures is suspended for 15 minutes as stock index CSI 300 that tracks the largest cap stocks in Shenzhen and Shanghai fluctuates by 5 percent.

Trading will be suspended fore the remainder of the day as the index moves by 5 percent after 2:45 pm or 7 percent any time during the trading session. Market rout between June and August wipe out $5 trillion of the market value that prompted the capital market regulator in considering the circuit breaker mechanism, that is designed to temporarily stop trading to avoid market panic after the stock index fluctuated a certain percentage. Recent announcement revised the drafted rules that was circulated for public opinion which shortened the trading suspension time to 15 minutes down from the proposed 30 minutes.

Earlier investors have expressed their concerns that a 30 minute trading suspension will cause liquidity problems as individual stocks are subjected to the 10 percent daily trading limit. By shortening the suspension time, it will reduce the mechanism impact on the market liquidity. A spokesperson for the China Securities Regulatory Commission stated that the regulator would continue in improving the trading mechanism, which will base on future market responses once the new mechanism is introduced. Based on international experiences, the introduction of the circuit breaker mechanism is not a one for all decision and will need constant adjustment, present rules are based on the unique characteristics and trading habits of the Chinese market.

United States have already introduced a market wide circuit breaker mechanism after the stock market crash in 1987, wherein the country installed trading suspension mechanism for individual stocks after the flash crash in 2010. Stock market experiences substantial volatilities, the mechanism will protect the interest of small investors that are in a disadvantage due to the lack of information. The mechanism will help curb risk of trading stock index futures as trading suspension offers investors the opportunity in depositing additional cash to avoid forced liquidation.

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