Shutting markets to stem panic: Often the wrong medicine

Simply shutting down markets can be a tempting option to halt panic selling, but it's tantamount to breaking the thermometer to cure the fever, analysts say.

Rather than cooling flaring investor tempers, trading curbs can even fuel a rush to the exits as sellers hurry to offload stock while they can -- as China has this week discovered to its cost.

Analysts said authorities should use pauses in trading to actively soothe investor nerves, a strategy that China failed to implement during this week's trading fiasco.

After having its new trading "circuit breaker" tripped twice in the first four days it was in place, Chinese regulators backtracked on Thursday and suspended the suspensions, saying the were causing more harm than good.

Circuit breakers are pauses in trading or a shutdown for the trading day when share prices fall by a certain percentage, and their aim is to limit market volatility.

After plunges on the Shanghai and Shenzhen exchanges in August, which dragged down stocks across the globe wiping off trillions in valuations, Chinese regulators decided to introduce circuit breakers from January 1.

But the circuit breaker was triggered on the first day it was in force, on Monday, and then again on Thursday, when share prices tumbled 7 percent, provoking questions about its effectiveness.

"After weighing advantages and disadvantages, currently the negative effect is bigger than the positive one," the China Securities Regulatory Commission (CSRC) said in a statement.

"Therefore, in order to maintain market stability, CSRC has decided to suspend the circuit breaker mechanism."

- Circuit breakers counter-productive -

Analysts said Beijing's introduction of the circuit breaker this week had proved counter-productive, with investor fears of being unable to sell unwanted stocks outweighing any reassurance over market stability.

Circuit breakers are nearly universal on Western exchanges, but Christopher Dembik, an economist at Saxo Banque, said emerging markets differ from developed markets.

"It is possible to close the markets if measures are promptly put into place to reassure investors, otherwise its counter-productive," said Christopher Dembik, an economist at Saxo Banque.

"The major problem in China is that the market is still immature. You have a myriad of individual investors susceptible to panic selling and market shutdowns that are not always accompanied by measures that could calm trading at the reopening," he said.

The Chinese regulators had put into place a 15-minute trading halt when share indices fall by 5 percent, and closing for the day if the threshold of 7 percent is breached.

On Thursday, the Shanghai and Shenzhen exchanges were open for less than 15 minutes of trading overall. After the 15 minute trading suspension, it only took one minute for the slump to deeping to 7 percent and the exchange close for the day.

"The problem with two-stage circuit breakers is that triggering the first leads to triggering the second," said Jean-Louis Mourier, an economist at the brokerage Aurel BGC.

"Investors who didn't sell their shares fast enough rush to do so after trading resumes," he said.

For comparison, the NY Stock Exchange has 15-minute suspensions at drops of 7 and 13 percent the broad S&P 500 index with closing of trading at 20 percent.

In the West they are generally seen as being effective, such with the closing of Wall Street after the September 11 attacks in 2001.

"The oft-cited French example is the election of the Socialist Francois Mitterrand as president in 1981," said Jean-Pierre Pinatton, head of the supervisory board at the Oddo & Cie bank.

"The exchange took three days to open its doors, but it was much sounder to let investors digest the news," he said.

- 'Information is key' -

On the Paris stock exchange trading in a share quoted on the main CAC 40 index is suspended if it climbs or falls more than 10 percent during the session.

Only when 80 percent of the shares on the CAC 40 are suspended does the calculation of the index suspended, and the last time this happened in 2008.

"We have an array of protective measures that have been elaborated with regulators based upon experience," said Fabrice Peresse, who heads of monitoring of trading at Euronext, the operator of the Paris, Brussels, Amsterdam and Lisbon stock exchanges.

Pinatton said "suspensions should be as short of possible, because the longer they are the greater the risk they aggravate the panic."

But beyond the particularities of the circuit breakers, authorities face the challenge of restoring calm before trading resumes.

"Information is key," said Pinatton, because "the fundamental objective of a suspension is to protect savers."

Thus authorities need to take steps to ensure investors "have the elements they need to take informed decisions."