China U-turn stokes circuit breaker debate

Employed in equity markets worldwide, circuit breakers are used to temporarily halt trading on particularly volatile markets when they experience a certain percentage drop.They were first brought in following the 1987 stock market crash. However a global standard for the use of circuit breakers has never been set, and Hong Kong and Australia do not use the mechanisms at all. 

Last week, the circuit breaker proved too narrow for price changes in blue-chip members of the Shanghai CSI300; trading was stopped following a drop of 5 per cent.

As a result, investors in China's markets were drawn towards selling shares before the halt was called. Trading was closed down as soon as the market dropped 7 per cent. 

Hao Hong, Managing Director of Research at Bocom International told the Financial Times onine: "Clearly, the tight stops... has the magnet effect" as prices gravitate towards the breaker, and prompts a stampede that drains market liquidity."

"Once expectation for further decline is set, it can be a vicious spiral. [Low hurdles] can be easily triggered, given the intense volatility in this market", Mr Hong added. 

China's u-turn has implications for market controls globally. Exchange halts are usually brought into play when prices are pushed past a certain point or when a single large order exceeds security parameters. 

According to Patrick Wu at corporate finance advisor Duff & Phelps, circuit breakers are "designed to interrupt the free operation of markets and for that reason are usually doomed to failure, unless they're accompanied by measures that will have a long-term impact on asset prices, such as quantitative easing."

BlackRock is among the investors that argue that controlling measures can provoke, not pacify volatility. However, rather than abolishing circuit breakers, BlackRock advocates further integration of the technology into other markets such as futures and ETFs.