China’s circuit breaker: impact on funds

In response to turmoil in the China A-share market during the summer of 2015, the China Securities and Regulatory Commission (CSRC) introduced a new circuit breaker mechanism for the Shanghai Stock Exchange and Shenzhen Stock Exchange. The new measures came into effect on 1 January 2016.

The circuit breaker mechanism seeks to give some breathing space for the market to cool down under extreme volatility, and is tied to the benchmark CSI300 Index, which tracks the largest listed companies on the Shanghai and Shenzhen exchanges. In summary, if before 2.30pm on any trading day, the CSI300 Index moves 5% in either direction from its previous close, the circuit breaker will trigger a 15-minute trading suspension for all stocks on both the Shanghai and Shenzhen Stock Exchanges. A 5% fluctuation after 2.30pm will suspend trading until the market closes at 3.00pm. A 7% rise or fall in the CSI300 Index at any time will halt trading for the rest of the day. Once the circuit breaker is triggered, investors are not able to buy or sell China A-shares during the suspension.

Whilst the introduction of the scheme on 1 January 2016 was anticipated, a mechanism trigger on the year’s first day of trading was unexpected. A suspension was announced in the afternoon of Monday 4 January 2016 and the immediate impact of the mechanism on other markets became apparent. A drop in the Hong Kong stock market continued, and when the European and US stock markets opened, the decline followed suit. The circuit breaker threshold was again breached within half an hour of China’s stock market opening on Thursday 7 January 2016. Late that evening, the CSRC announced that the circuit breaker scheme would be halted indefinitely from the following day.

It was not immediately apparent how the trigger of the circuit breaker would impact both retail and privately offered investment funds. Shortly after the stock markets closed on Monday, fund houses started to review the offering and constitutive documents for their funds which invest in China A-shares. There are a number of issues to be considered, for example:

• Would the suspension of trading triggered by the circuit breaker mechanism also trigger a suspension in valuation and dealing of the funds investing in China?
• Is the definition of the Dealing Day in a fund’s constitutive and offering documents wide enough to cover the circuit breaker such that when the mechanism is invoked it would not be considered as a Dealing Day?
• The need to enhance disclosures in the fund’s risk factors to address the impact of the circuit breaker in relation to the dealing of the funds and the liquidity of the fund’s underlying investments in China – e.g. the buying and selling of A-shares.
• The content of any investor notices.
• In respect of retail funds authorised by Hong Kong’s Securities and Futures Commission (SFC), will the updates need to be pre-approved by the SFC, or can they be post filed as immaterial changes, or clarifications? This is likely to depend on the nature and scope of the amendments and in some cases prior approval may not be required.

Mainland funds recently authorised by the SFC under the mutual recognition scheme (MRF) have already taken action including the issuance of investor notices. Meanwhile, fund houses offering non-MRF funds such as QFII, RQFII and even UCITS with significant China A-shares investments are also advised to review the position and consider whether any updates should be made, pending the implementation of a further circuit breaker scheme, either in its original or revised form.

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李崇瀚

合夥人 | 金融服務

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