Lessons for Vietnam from the circuit breaker policy

The Role of Trading Halts

The World Federation of Exchanges defines a circuit breaker as "a temporary mechanism to halt continuous trading of one or more securities due to market variables exceeding predefined thresholds." A circuit breaker, in other terms, is a temporary trade halt used to reduce excessive volatility and restore trading order in the stock market.

Circuit breaker regulations in the stock market apply to a wide range of goods in most nations, including stocks, bonds, options, and futures contracts. The circuit breaker is critical in ensuring the national stock market's stability. During times of upheaval, panic selling may occur, and the circuit breaker is used to restore the market's inherent stability.

Circuit breakers, on the other hand, might have an influence on market price dynamics and trading behavior. In the paper "Dark Side of Market Circuit Breakers," Hui Chen and colleagues (2019) proved that as the market approaches the circuit breaker, selling pressure increases, causing stock values to fall. For example, when the market approaches the circuit breaker threshold during a decline, price volatility tends to rise, and implementing the circuit breaker policy may result in (1) increased negative price volatility and (2) increased abnormal trading activity, indirectly destabilizing prices during periods of sharp market decline.

History of Circuit Breakers at NYSE

Market circuit breaker events (temporary halts or closures) in the United States stock market can occur for a variety of reasons. Following the assassination of US President Abraham Lincoln in 1865, the New York Stock Exchange (NYSE) halted trade for a week.

The NYSE stopped for 10 days in 1873 owing to a major crisis brought on by the bankruptcy of Jay Cooke & Company, a bank that had insured the issue of silver bond debts. NYSE had to suspend operations for four months during World War I in 1914. Due to the instability of the housing crisis, trading on the NYSE was regularly stopped in 2008. Due to technological challenges on the trading floor, the NYSE momentarily paused trading for a few hours in 2015. Due to worries regarding information connected to the Coronavirus and the protracted epidemic of Covid-19 over the following two years, the market circuit breaker mechanism on the NYSE was activated many times in 2020.

The Market-Wide Circuit Breaker (MWCB) Rule was updated and adopted in the United States on April 8, 2013. The stock market circuit breaker is a technique used to temporarily suspend trading if market prices fluctuate significantly, potentially increasing or decreasing market liquidity. In some situations, the competent regulatory authority may decide to close the market before the trading session ends.

According to the Securities and Exchange Commission (SEC), the market circuit breaker activation criteria are separated into three levels: 7% (Level 1), 13% (Level 2), and 20% (Level 3). These levels are calculated daily using the previous day's S&P 500 Index closing price.

Furthermore, the SEC has implemented single-stock circuit breaker rules to prohibit big, rapid price movements in particular stocks. A single-stock circuit breaker establishes both upper and lower price limit s within a price range. This price range is established as a percentage above and below the stock's average price for the previous five-minute trading session. According to the National Market System (NMS) principles, these price ranges are defined at 5%, 10%, and 20% volatility levels, depending on the stock's categorization (Level 1 or Level 2). Trading in the stock is paused for five minutes if the stock price moves into the price range and does not return to the range within 15 seconds.

Examining China's Circuit Breaker Failure

However, it is hard to ignore governments' failures to adopt market circuit breaker legislation. Following the chaotic market fall in 2015, China adopted circuit breaker laws with a 5% halt level in January 2016, trying to calm the market.

In actuality, the market circuit breaker was activated twice in the first four days of installation and swiftly deactivated. Overall, the failure of China's market circuit breaker policy was caused by extremely strict halt threshold laws, which had an influence on market trading flexibility. As a result, national securities regulatory bodies are advised to create suitable halt criteria that are neither too slack nor too tight, but are based on the underlying market volatility level. Furthermore, more effective solutions should be found, such as building a circuit breaker mechanism that takes into account not only price levels but also market psychology or potentially impacting information.

Lessons for Vietnam

Securities regulations in Vietnam provide provisions for market circuit breakers. A market circuit breaker is a mechanism that automatically suspends trading during a trading session when the price of securities or the securities index fluctuates and reaches predefined thresholds on the stock trading system, according to the regulation in Clause 2, Article 2 of Circular 120/2020/TT-BTC. Regarding the market circuit breaker mechanism, the State Securities Commission of Vietnam may opt to use either the market circuit breaker mechanism or a combination method that comprises both the market circuit breaker and price fluctuation restrictions based on realistic market conditions.

As a result, after receiving permission from the State Securities Commission, the Vietnam Stock Exchange has the ability to decide on the market circuit breaker mechanism, in line with the provisions of point d, Clause 2, Article 302 of Decree 155/2020/N-CP and Article 5 of Circular 120/2020/TT-BTC.

In actuality, the Vietnamese stock exchange has yet to implement a market circuit breaker mechanism. However, given the stock market's ongoing development rate and rising levels of risk, particularly as a result of the effect of numerous local and foreign variables, the need for a market circuit breaker mechanism is expected to emerge in the near future.