Illustration: Peter C. Espina/GT

After the summer stock market slump last year, China's securities regulators decided to adopt a circuit breaker mechanism similar to those used in mature overseas markets to help curb excessive volatility. But it came as a shock when the mechanism was triggered on Monday, the first day it came into effect.

The system suspends trading when the CSI 300 Index of blue chip stocks fluctuates by a certain degree compared to close of trading on the previous trading day. The index was down by 5 percent at 1:12 pm, triggering the first threshold of a 15-minute break in trading. After that, the market did not stabilize at all. Six minutes after trading resumed, the index was down by 7 percent, leading to a halt in trading for the rest of the day.

Many analysts said the fall had nothing to do with the new circuit breaker mechanism, but they are deceiving themselves. The rout on Monday was definitely a result of the new system. No matter how perfectly designed a trading system is, it usually takes a long time for it to work properly. Most trading systems are flawed, and there are problems when they start.

Under the new system, if the CSI 300 Index falls by 4 percent, investors will start to be concerned about the possibility that a trading suspension is imminent. Therefore, they tend to sell more before this point is reached, which has the effect of leading to the trading suspension.

Then, after trading resumes 15 minutes later, investors are concerned that the 7 percent threshold might soon be reached, leading to even more irrational selling. As a consequence, the market quickly sinks to the 7 percent level. This is a vicious cycle, a self-fulfilling prophecy. The newly introduced circuit breaker mechanism was the catalyst for Monday's sell-off.

Some foreign investors said it was because of the nature of China's stock market, in which roughly 80 percent of the investors are small retail investors, and with large institutions playing a smaller role than in mature overseas markets. In theory, this means there is a greater risk of collective panic.

My bet is that investor sentiment is actually not so different across the world. Any kind of panic can spread easily throughout global markets and trigger massive sell-offs.

Therefore, China's circuit breaker system, along with weaker-than-expected domestic economic forecasts and political tension in the Middle East, have led to global sell-offs.

Markets in Japan, South Korea, Taiwan, Hong Kong and India all tumbled over 2 percent on Monday. And in Europe, the FTSE 100 in London closed down 2.4 percent, Germany's Dax index dropped 4.3 percent and France's CAC 40 declined 2.7 percent. The Dow Jones Industrial Average opened with a plunge of over 2 percent, and ended with a 1.58 percent loss. Even though it is not fair to attribute such fluctuations completely to China's newly adopted circuit breaker mechanism, it certainly had an effect. 

Perhaps the biggest concern is recent weakness in the yuan. On Monday, the yuan exchange rate against the US dollar weakened by 0.96 percent. Depreciation of the yuan will definitely exert an influence on China's stock market as well as the domestic financial market. This tendency is even more likely to lead to sell-offs in China's stock market than the newly adopted circuit breaker system.

The author is a professor with the School of Economics at Qingdao University. bizopinion@globaltimes.com.cn