Shanghai Stock Exchange, Shenzhen Stock Exchange, China Financial Futures Exchange Issue Rules For Circuit Breaker Mechanism For Index

On December 4, as approved by the China Securities Regulatory Commission (CSRC), the Shanghai Stock Exchange (SSE), the Shenzhen Stock Exchange (SZSE) and the China Financial Futures Exchange (CFFEX) officially issued the rules for the index circuit breaker, which will come into effect on January 1, 2016. The circuit breaker mechanism for index is an important institutional arrangement to further improve the trading mechanism on China’s securities and futures market, safeguard the market order, protect the rights and interests of investors and promote the long-term, stable and healthy development of the capital market.

The circuit breaker mechanism for index to be implemented has been formed after being improved on the basis of public solicitation of opinions on the draft rules. From September 7 to 21, the three exchanges publicly solicited opinions on the rules of the circuit breaker mechanism for index, which was highly concerned by all market participants who returned 4,861 opinions and suggestions of all kinds to the three exchanges. Generally speaking, the market participants have expressed recognition for the overall plan of the mechanism. After carefully studying and demonstrating the opinions and suggestions, the three exchanges have accepted the most concentrated ones with others not adopted at present. The details are as follows.

Firstly, the issue concerning the time of trading suspension for the circuit breaker. According to the publicly solicited opinions, most investors suggested that the suspension time of 30 minutes for circuit breaker is too long, with such opinions taking the highest proportion. In order to mitigate the impact on the market liquidity when giving play to the role of the circuit breaker mechanism, the three exchanges have shortened the trading suspension time after triggering off the circuit breaker limit of 5% from 30 minutes to 15 minutes, but the arrangement was retained that the trading suspension will continue until the closing when the limit of 5% is triggered off near the closing or the limit of 7% is touched at any time during the trading session. The main reasons include: first, the sharp fluctuations usually take place during the final session before closing, and the rule that the trading shall be suspended until the closing when the circuit breaker limit of 5% is triggered off at or after 14:45 is conducive to preventing the abnormal fluctuations during the period. Second, the CSI 300 is an important index product reflecting the overall trends of the stock markets in Shanghai and Shenzhen, with such features as high representativeness and strong resistance to manipulation. When it goes up or down by 7%, it usually means that sharp volatility has taken place in the market, which is likely to face the extreme systemic risks. Therefore, the market needs more time to calm down so as to prevent the spreading panic from intensifying the market fluctuations. In terms of the overseas markets, the markets in the United States, South Korea, India and other regions have set the arrangements for trading suspension until the closing when the highest circuit breaker limit is triggered off, in a bid to prevent the systemic risks.

Secondly, adaptation to the current price limit system. Some market participants said that if the current price limit system remains unchanged, it is not so necessary to implement the circuit breaker mechanism. They suggested relaxing or cancelling the price limit system for the stocks while introducing the circuit breaker. According to the research, the circuit breaker mechanism and the price limit system are both the measures for stabilizing the prices in the short term. But the two systems are different to some extent in targets and principles of the functions and other aspects. The price limit system sets the limit for the price fluctuations in the trading of a single securities product, mainly preventing severe price fluctuations of a single securities product, and the securities product can still be traded at the price limits; the circuit breaker mechanism for index means suspending the trading of the entire market for some time when the fluctuations of a market benchmark index exceed a certain range, so as to guard against the excessive responses of the market; after the circuit breaker is triggered off, all the securities products within the range of the circuit breaker will have the trading halted during the suspension session. According to the abnormal fluctuations in the stock market this year, the price limit system was not enough to play the role in stabilizing the market in extreme cases, and it has been increasingly necessary to introduce the circuit breaker mechanism for index. In addition, as the price limit system is a fundamental institutional arrangement for China’s securities market, relaxing or cancelling the system will affect the current institutional arrangements such as the system of management of settlement risks, the risk control measures for the leverage-related businesses and the market supervision indicators, and have significant impact on the trading habits of the investors. Therefore, it is unlikely to relax or cancel the system in the near future. In the next step, the three exchanges will also, on the basis of the implementation of the circuit breaker mechanism for index, coordinate the effort and pace of reform and the bearing capacity of the market, and continue to improve the related trading mechanisms, so as to promote the steady and healthy development of the capital market.

Thirdly, the issue of the limits for the circuit breaker. In the opinion of some market participants, the current limits are relatively low, so there may be many times to trigger off the limits and the too small gap may lead to the two limits triggered off in succession. They suggested setting one limit, or increasing the limits to 6% and 8%, or widening the gap between the limits. We believe that with the 10% price limit retained, the limits of the index circuit breaker that can be selected are restricted, and the two limits of 5% and 7% introduced by the three exchanges are on the basis of the analysis and calculation of the historical data in the past 11 years. In specific, the first limit of 5% may coordinate both the demands for setting the period of calming down and maintaining the normal trading; although there are few cases of triggering off the 7% limit, it is a significantly abnormal case that should be prevented and should be also taken into account, so as to stop the sharp and sudden increases and drops and other extremely abnormal market situations from continuing.

Fourthly, the selection of the benchmark index. Some market participants said that the CSI 300 index cannot reflect the trends of the stocks with small and medium-sized market values. Usually, we should select the index characterized by high representativeness, significant influence and difficulty in being manipulated as the benchmark index for the circuit breaker, and the CSI 300 index has the above characteristics. Compared with the single-market indexes, the CSI 300 index can reflect the overall market fluctuations for A shares in a more comprehensive way; meanwhile, the CSI 300 index is also dominant on the market in the coverage of market value and the number and size of the tracked products.

Fifthly, the issue of two-way circuit breaker. Some market participants suggested only setting the down limit for the circuit breaker. We believe that the two-way circuit breaker is more conducive to curbing excessive trading and controlling the market volatility. As in the structure of the domestic market investors, the small and medium-sized individual investors are in the majority, there have been significant two-way price fluctuations with both panic drops and excessively rapid increases, including the sharp increases within a short time caused by accidents. Therefore, the “surging” market also needs the circuit breaker mechanism to stabilize the market sentiments and prevent the overreaction of the investors to the increases in the market, so as to enable the investors to have more time to make further judgment whether the current prices are reasonable.

We should also explain that there are slight differences among the specific business arrangements of the three exchanges in implementing the circuit breaker mechanism, and the investors are requested to pay attention to the Q&A on the business and related announcements to be issued by the exchanges.