A few weeks ago, ANC’s business program, Business Nightly, interviewed me when China activated the circuit breaker system for its stock market.
Believe it or not, China’s circuit breaker system was activated immediately after it was put in place last Jan. 4. To make matters worse, the circuit breaker was activated twice within a span of three trading days—the first on Jan. 4, when the market plummeted by five percent; and again three days later on Jan. 7, when the stock market plunged by seven percent. In both instances, the first pause was quickly followed by trading being shut down.
Jan. 7 was China’s shortest trading day ever. As a result, the China Securities Regulatory Commission suspended the circuit breaker and decided to reevaluate strategies.
What is a circuit breaker?
A circuit breaker is a trading halt or suspension in a stock market when the prescribed threshold is reached. It is usually benchmarked against the main index of the stock market.
In the case of China, for example, the circuit breaker is benchmarked against the CSI 300 index, which is composed of the largest 300 stocks listed in the Shanghai and Shenzhen stock exchanges.
It has two thresholds. If the CSI drops by 5 percent, trading is halted for fifteen minutes. If the market further drops to 7 percent, then trading is suspended for the rest of the trading day.
Since a circuit breaker is really an artificial intervention, not all markets have it. For example, more mature markets like Australia, Hong Kong and Singapore do not have circuit breaker systems.
Some mature markets have adopted it, on the other hand. The United States, for example, put it in place as a reaction to the 1987 stock market crash. This was more popularly known as the Black Monday, which plunged the stock market more than 22 percent and erased more than $500 billion investments in one day.
Some stock exchanges employ circuit breakers that have a wider range than what China has. In fact, a criticism on China’s circuit breaker is that the range is too narrow (5 percent and 7 percent), which can lead to a massive sell-off. Thailand’s circuit breaker is at 10 percent and 20 percent while Malaysia’s is at 10, 15 and 20 percent.
Other markets have one threshold: There is only a temporary shut down at 10 percent and no other trading halts thereafter.
PSE’s version
During my term as PSE president, we put in place a circuit breaker amid the 2008 financial crisis that saw global stock markets very volatile. Being relatively small and undeveloped, our market was often left at the mercy of developments in bigger markets.
Our circuit breaker rule basically provides that if our main stock market index (PSEi) drops by at least 10 percent from the previous day’s close, then trading is halted for fifteen minutes but immediately resumes thereafter. The trading halt will be implemented only once in a trading day and will not be triggered if the drop occurs thirty minutes or less prior to the market close.
Unlike in the case of China, Malaysia and Thailand, there is only one threshold, which is a 10-percent drop from the previous day’s close.
Since we put our circuit breaker system in place, we used it only once when the PSEi went down by more than 12 percent during the 2008 US stock market crash. I don’t see it being activated in the near future given the country’s sound macro-economic fundamentals.
Other forms of trading halts
Circuit breakers are to be distinguished from other kinds of trading halts or suspensions.
For example, the PSE has a trading band rule. If the price of a particular stock goes up or down by 50 percent of the previous day’s closing price, then trading of that stock is suspended for the day. (Strictly speaking, this is known in other stock exchanges like the London Stock Exchange as single-stock circuit breaker).
Likewise, we have rules on trading halts. If at least one-third of the brokers who use the PSE’s trading system cannot access it due to system problems (e.g., server or network problems), then the Exchange can halt trading.
There is also a disclosure rule that states if a material development occurs during trading hours, the issuer must request for a trading halt to enable investors to digest the information. We also have involuntary trading suspension as when trading of a particular stock is suspended by the PSE as penalty for failure of the listed company to comply with disclosure rules.
What distinguishes a circuit breaker from other forms of trading suspension is that it is market-wide. Indeed, it is called circuit breaker because it shuts down trading in the whole market in the same manner that a circuit breaker shuts off electricity in the entire household.
It is also market-driven as it is triggered by a sudden drop or rise in the stock market index against which it is benchmarked. It is designed to provide an emergency break or timeout during wild market swings to calm down investors and to restore normalcy in the stock market.
(The author, formerly PSE president and CEO, is now a senior partner at Accralaw and president of the Shareholders’ Association of the Philippines or SharePHIL. He also teaches Securities Regulation in Ateneo Law School. The views expressed in this column are exclusively his and may not be attributed to the institutions where he is presently connected with. He can be contacted at francis.ed.lim@gmail.com.)