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Can Singapore Exchange Limited’s Circuit Breakers Really Protect Investors?

Singapore Exchange (SGX: S68), operator of the Mainboard and Catalist stock exchanges here in Singapore, announced earlier today that it would be introducing circuit breakers to the securities market from 24 Feb 2014 onwards “as an additional market safeguard.”

Bloomberg had reported back in October 2013 that the company had plans for a circuit breaker that would be implemented early this year. SGX had started to explore the initiative after the massive collapse in share prices of Blumont Group (SGX: A33), Asiasons Capital (SGX: 5ET), and LionGold Corp (SGX: A78) early in the month (all three shares are now still more than 90% below where they were prior to their collapse).

According to today’s announcement, the circuit breakers would initially be applied to two types of securities: constituent shares of both the Straits Times Index (SGX: ^STI) (which includes SGX) and the MSCI Singapore Index; as well as securities that are priced at S$0.50 and above. SGX added that “stapled securities, funds, exchange traded funds, exchange traded notes and extended settlement contracts” would also be part of the basket of ‘securities’ in question. All told, these securities together account for 80% of the trading done on Singapore’s stock market.

The circuit breaker would be triggered if a security actually rises or falls more than 10% from the reference price, which is the last traded price of the security from at least five minutes ago.

If the breaker is triggered, there would be a five-minute cooling-off period that would only allow trading to take place within a +/- 10% range from the reference price. After the cooling-off period ends, trading would resume normally with a new reference price that could be set during the cooling-period itself.

SGX would also be implementing a new error trade policy at the same time as the circuit breakers. The new policy would not allow any trades for all securities, except bonds, to be cancelled if the price of the transaction is within 5% of the last traded price. For structured warrants, trades can’t be cancelled if they are made within a 25% price range from the last valid price.

The company added that “trades done outside of the relevant price range are eligible for review by SGX. For bonds, any error trade will be eligible for review.”

According to Muthukhrisnan Ramaswami, president of SGX, the two new measures – the circuit breaker and the error trade policy – “will assure investors of continued safety and transparency even under volatile market conditions.” The initiatives would also “compliment [SGX’s] existing safeguards in support of a fair, orderly, and transparent market.”

So there you have it, the long-awaited circuit breaker that can likely help to safeguard investor’s interests.

But while the circuit breakers can help provide “safety and transparency”, can they actually help prevent investors from facing massive losses like what happened with shipping firm Cosco Corp. (SGX: F83), whose shares have fallen in price by more than 90% from almost S$8 in Oct 2007 to S$0.74 today?

Cosco Corp.

 

30 Oct 2007: Price

S$7.75

30 Oct 2007: Price-to-book value

15

30 Oct 2007: Price-to-Earnings

65

Today: Price

S$0.74

Today: Price-to-book value

0.8

Today: Price-to-Earnings

33

Source: S&P Capital IQ

From the table above, we can see how investors were willing to pay very high valuations for Cosco’s shares back then, essentially embedding expectations for huge growth going forward. When the growth didn’t pan out – earnings fell by more than 80% from 30 Oct 2007 till today – reality set in and expectations were reset.

Can circuit breakers help prevent investors from paying crazy prices for a business? Well… they can’t. Share prices reflect the underlying value of a business over the long-term and that’s something investors have to realise if they want to really protect their capital.

Blumont’s crazy 90% fall in the space of three trading days raised some questions. But the company was also selling for 500 times earnings and 60 times book value shortly before its collapse. If anything, questions should also be asked of the ‘investors’ who were literally paying through the nose for Blumont’s shares… What were they thinking!?

No amount of circuit breaking could have saved America investors in 1999 when they were awarding market values in the billions for internet companies with no revenue and no earnings. Only a realisation that market prices had been ripped so far apart from businesses’ true economic values could have saved them. There’s a lesson in there for us.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.