Relevant Regulations Of Shanghai Stock Exchange, Shenzhen Stock Exchange And China Financial Futures Exchange On Circuit Breakers

With the approval of China Securities Regulatory Commission, Shanghai Stock Exchange (SSE), Shenzhen Stock Exchange (SZSE) and China Financial Futures Exchange (CFFE) issued the relevant regulations on circuit breakers on December 4, 2015, which will be effective as of January 1, 2016. The introduction of the circuit breaker mechanism is an important institutional arrangement to further enhance the trading mechanisms of China securities and futures markets, maintain market order, protect investors’ interests and promote the long-term, steady and sound development of the capital market.

The circuit breaker mechanism was launched after solicitation of public opinions on a draft plan. From September 7 to 21, 2015, the SZSE, the SSE and the CFFEX solicited public opinions on draft circuit breaker regulations, which aroused intense attention from market participants who proposed 4861 opinions and suggestions. Generally, all the market participants agreed with the overall plan. After earnest study of all the opinions and suggestions, the three exchanges accepted those on focal issues and shelved some others. Specific explanations are as follows:

1. Circuit breaker durations. The solicitation reveals that investors generally think that the 30-minute halt is too long. In order to minimize impact on market liquidity while allowing the circuit breaker mechanism plays its role, the three exchanges reduced the 30-minute duration for triggering the 5% threshold to 15 minutes while retaining the arrangement of halting trading to the market close after triggering the 5% threshold during the market close session or after triggering the 7% threshold at any time of the whole day. The main considerations are: firstly, more often than not, domestic markets experience dramatic volatility during the market close session and the arrangement of halting trading to the market close for triggering the 5% threshold after 14:45 will help guard against risk of unusual market movement during the market close session. Secondly, as a key index product that reflects the overall market movement of Shanghai and Shenzhen markets, CSI 300 Index features good representation and anti-manipulation and a 7% rise or fall in CSI 300 Index often implies drastic market volatility and extreme systemic risk. Therefore, the market needs a cooling-off period to avert panic selling and sharp market fluctuations. Many overseas markets such as the US, Korea and India have similar arrangement of halting trading till the market closes after triggering the highest level threshold in order to prevent systemic risk.
2. Connection with the existing daily price limit system. Some market participants said that, given that the existing daily price up/down limit system is to be retained, there is no need for introducing circuit breakers. They suggested relaxing or scraping the daily price limit system for individual stocks and introducing circuit breakers for individual stocks. Our study shows that the circuit breaker mechanism and the daily price limit system are similar in nature as they are both short-term price stabilization measures. However, they are somewhat different in the objects they apply to as well as in working principle. The daily price limit system sets a limit on the price movement of individual securities and is designed to avoid sharp price fluctuation of individual securities. Under the daily price limit system, securities can still be traded at the daily price limit. In contrast, the circuit breaker mechanism halts trading of the whole market for a period of time when the movement of the market benchmark index exceeds a specified limit to avoid over-reaction of the market. When the relevant threshold is triggered, all the securities within the circuit breaker scope will be halted temporarily during the circuit breaking period. This year’s unusual market volatility indicates that the daily price limit system alone is unable to stabilize the market under extreme circumstances and that it is highly necessary to introduce the circuit breaker mechanism. In addition, as the daily price limit system is a basic institutional arrangement in China securities market, relaxing or scraping the system is improbable in the short run as that will have effect on the existing institutional arrangement such as the settlement risk management system, risk controls in leverage business, and market surveillance indicators and will also have significant effect on investors’ trading practices. In the next step, the three exchanges will continue to enhance the relevant trading mechanism by taking into account the implementation results of the circuit breaker mechanism and striking a balance between the reform momentum and pace and the market acceptability so as to promote the steady and sound development of the capital market. 
3. Thresholds. Some market participants said that the existing thresholds are too low and may be triggered frequently and that the interval between the two thresholds is too narrow and thus may be triggered consecutively. They suggested setting only one threshold or raising the threshold to 6% to 8% or considering expanding the gap between the existing thresholds. In our opinion, given that the existing 10% daily price up/down limit is to remain, we have limited options for circuit breaker thresholds. The current two thresholds of 5% and 7% are put forward by the three exchanges on the basis of their analysis of the historic data over the past 11 years. Of the two thresholds, the first threshold of 5% can meet both the needs of providing a cooling-off period and maintaining normal trading. Though the second threshold of 7% is seldom triggered, it should also be considered as major abnormal situations so as to stem continued extreme market movements such as drastic advances and declines.
4. Selection of benchmark index. Some market participants said that CSI 300 Index does not reflect the price movement of small- and mid-cap stocks. Often, the circuit breakers benchmark index selects highly representative, influential and anti-manipulative index. CSI 300 Index has all such features. Compared to a single-market index, CSI 300 Index can better reflect the overall movement of the A-share market. Moreover, its coverage of market capitalization and the number and sizes of the products tracking the index are all high compared with other indices.
5. Two-way circuit breakers. Some market participants suggested setting a circuit breaker only for market price declines. In our opinion, the two-way circuit breaker is more conducive to curbing over-trading and controlling market volatility. As the domestic market is dominated by retail investors, sharp two-way price fluctuations have led to not only slumps in panic selling but also precipitous rises, including short-term dramatic rises caused by accidents. Thus, when the market encounters steep rises, the circuit breaker mechanism is needed to stabilize the market sentiment, prevent the investors’ over-reaction to market rises and give more time for the investors to further determine whether the current prices are reasonable or not.

Another issue that must be clarified is that the specific business arrangement of the three exchanges in implementing the circuit breaker mechanism is slightly different. Investors are required to pay attention to the business Q&As and relevant announcements released by the exchanges.