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Hong Kong's Warrants Market Dries Up

by Mary Swire, Investors Offshore, Hong Kong

27 December 2001

Hong Kong is the world's fourth largest market for trading in share warrants, yet uncertainty surrounding the introduction of new approval rules for them has led to a serious shortage of tradeable instruments, and the drought in warrant trading is expected to worsen in the next few weeks as the regulatory changes hold up new issues.

Under the old regulations issuers could list warrants by placing them with institutional investors only, but the SFC criticised the old mechanism in June, saying it could encourage issuers to fabricate subscription figures by arranging for connected parties to take up warrants on the understanding that they could sell them back later. As a result, the new rules end the placing requirements and create a formal market-making system to ensure the warrants' liquidity.

Investment banks stopped issuing new warrants in June in anticipation of the launch of this month's new regulations and precipitating the present dearth of trading. There were 58 traded on the market at the beginning of the month, of which 36 will expire this month, according to Hong Kong Exchanges and Clearing. This means only 22 warrants will be left in the market in the new year if the SFC fails to give the green light for new issues, compared with nearly 300 at the end of last year.

Quoted in the South China Morning Post, Credit Lyonnais director Eddie Tam Sun-keung said the SFC recently had required would-be issuers to clarify further some conditions and terms in their documents. "The deadline for replying to the questions is December 29," Mr Tam said. He said one of the SFC's main concerns was the legal status of such warrants - whether the issue was part of the capital structure for issuers. If so, such warrants could be regarded as debentures and would need to comply with HKEx's listing rules, which require the directors of issuers to bear civil liability for any fault arising from the instruments.

Warrants are similar to traded options, but are issued by investment banks on listed company stocks rather than by the exchange. They are seen as being riskier for investors because they do not have the standardised terms of exchange-traded options and usually carry longer-term expiry dates. The investment houses say that the SFC is now applying rules similar to those it applies to listed securities, so that they have to prepare what is effectively a prospectus, lengthening the approval process. Thus, the attempt of the regulators to improve transparency and liquidity for investors may simply have the usual and counter-productive result of driving trading away into freer markets and instruments.

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