It’s not uncommon for a new policy to go through some trial and error. But it’s not often the trial occurs the first day the policy goes into effect and rarely is the error so big.
But when it is, you have to go back to the drawing board. On Tuesday, the overseeing China Securities Regulatory Commission signaled it’s willing to consider tweaking the country’s new market circuit breakers after analysts blamed the rules for exacerbating a $590 billion rout in stocks on Monday.
On Monday, the first day of trading in 2016, the Chinese securities regulator instituted new market circuit breakers, created in the wake of last summer’s stock market rout.
In a case of extremely poor timing, it just so happened that the Caixin Purchasing Manager’s Index was released the same day, and the news wasn’t good. It showed the manufacturing sector has contracted for the 10th consecutive month.
This sent the CSI 300 Index tumbling 5%, which triggered the new circuit breakers to halt trading on the market for 15 minutes. When the market resumed, investors rushed to sell, sending the index lower and quickly hitting the 7%-decline circuit breaker, which shuts the market down for the rest of the day.
Citigroup, Deutsche Bank and Nomura Holdings all said the rules failed to restore calm on Monday as investors scrambled to exit positions before getting locked in by the halts, reported Bloomberg.
“This mechanism, as per the Chinese regulation body, aims to reduce A-share volatility,” Jason Sun, a strategist at Citigroup in Hong Kong, wrote in a report. “Instead, to a certain extent, it may raise short-term liquidity fears if investors are not able to cash out in a timely fashion.”
With the Chinese markets causing a world-wide sell-off on the first trading day of the new year, the Chinese authorities realized they had a problem on their hands.
Policy makers need to “gradually explore, gain experience and make adjustment” to circuit breakers, China Securities Regulatory Commission spokesman Deng Ge said in a statement on Tuesday. The one positive, the halts took effect without any major technical problems.
Market analysts are suggesting that the CSRC widen the threshold for the first halt beyond 5% and create a bigger gap between trigger levels for the initial suspension and the full-day halt, reported Bloomberg.
“Clearly, the tight stops of China’s circuit breaker at 5% and 7% have a ‘Magnet Effect’ as prices gravitate towards the breaker, and prompt a stampede that drains market liquidity,” Hao Hong, the chief China strategist at Bocom International Holdings, wrote in a report.
China’s threshold for trading halts looks “quite tight” versus circuit breakers in other markets, according to Deutsche Bank strategist Yuliang Chang. In the US, trading is temporarily stopped after the Standard & Poor’s 500 Index falls 7% and again at 13%. Only when losses hit 20% is the market closed for the rest of the day.
The two trigger levels in China, which come within two percentage points of each other, are “likely too close to each other and added to investors’ fears,” wrote Wendy Liu, a strategist at Nomura in Hong Kong. She pointed to comparisons with the U.S. and South Korea, where halts kick in at swings of 8%, 15% and 20%.