Chinese market regulators blew it

As a U.S. financial regulator for seven years, my mantra was always: Whatever you do or say, don't move markets. Let markets be as free as possible and only have needed constructs to protect investors. The Chinese regulators have, unfortunately, blown it.

On July 8 of last year, the Chinese Securities Regulatory Commission (CSRC) put in place a six-month ban on larger shareholders (those with over 5 percent of the stock) from selling. The impact is that well over 75 percent of shareholders were banned from selling. As the Chinese economy continued a slow decline, these shareholders were increasingly nervous. Many wanted to sell, but due to CSRC's regulatory fiat, were unable to do so.

This week, many thought, would end the troublesome circumstance. However, other shareholders, fearing that enormous selling pressure was about to commence (perhaps as much as 150 billion yuan, which is about U.S. $23 billion) began bolting. They sold and sold and sold. On Monday, new circuit breakers (price collars or limit ups or downs on how much the market could rise or fall) were hit and paused trading on the Shanghai Composite Index. On Thursday, the 7 percent threshold was reached, halting all trading, less than half an hour in the entire trading day.

What all this says is more about getting the right balance between free markets and appropriate regulation than anything else. Regulators should not be in the business of trying to impact prices or trading. They should be stock or commodity blind and price neutral. The CSRC, perhaps well-intentioned, massively missed that mark by mandating a majority of stocks would not trade for months. That pressure has brought about, along with the declining Chinese economy, a record-breaking negative beginning to the year in Chinese stocks, which has also impacted other markets around the world.

To make matters worse, the CSRC has now determined that the circuit breakers are not in force. This could result in extreme volatility (time will tell). They have gone from being too prescriptive with poorly calibrated circuit breakers, to having no circuit breakers whatsoever! Meanwhile, they haven't indicated when or if shareholders will be able to sell…creating even more uncertainty. (By the way, if you didn't have Chinese stock, who would want to trade in such a market?)

In the U.S., as a result of Black Tuesday in 1987, circuit breakers were put in place. Those have continually been recalibrated. In 2012, following the Flash Crash of 2010, I worked with my financial regulatory colleagues to put in place harmonized circuit breakers in future and equity markets. They have, knock on wood, worked fairly well. That said, we learned after being burned. The same is taking place now in China.

Balancing a free market and prescriptive regulatory approach is a delicate task. The CSRC clearly hasn't found that balance. That might be acceptable if it only impacted China, the world's second largest economy, but it also impacts the rest of the world. Let's hope they get it together soon.

All of this makes a stronger case than ever for having global market regulatory structures which are more harmonized. Today, we have international markets which operate 24-7-365. While no induvial national regulator has a requirement to harmonize with other national regulators, that is clearly what is needed. Such is true not only with regard to circuit breakers, but with regard to all other financial regulation.

Commentary by Bart Chilton, former commissioner on the Commodity Futures Trading Commission. He is currently a senior policy advisor at the global law firm DLA Piper. He is also the author of "Ponzimonium: How Scam Artists Are Ripping Off America."

For the latest commentary on markets in the U.S. and around the world, follow @CNBCopinion on Twitter.