Citi’s exit from Hong Kong-listed warrants and callable bull bear contracts (CBBCs) market in December 2014 as a result of shrinking margins represented the latest casualty of a competitive environment that has seen a number of foreign providers such as Bank of America Merril Lynch (BAML), Deutsche Bank, Royal Bank of Scotland (RBS), Barclays and Rabobank turning their backs on the domestic listed derivatives space.
In August, according to data from the Hong Kong Exchange (HKEx), JP Morgan stood as the top issuer of warrants and the fifth in terms of CBBC issuance. The US bank started expanding its warrants & CBBC business in 2010 by investing resources and building a sophisticated platform in Hong Kong, and has been gaining market share in a segment that had a turnover of US$379bn in 2014. SRP spoke to Yowjie Chien (pictured), head of warrants trading and marketing for JP Morgan Asia, about the market environment, the reasons for warrants and CBBC products to dominate the market and how these products complement traditional structured products.
How would you describe Hong Kong’s warrant/CBBC market, and JP Morgan’s position in this segment of the market?
Hong Kong is the world’s largest warrants market and currently accounts for approximately 20-30% of Hong Kong’s cash on a daily basis (including both warrants and CBBCs). It is a very competitive market where we have seen in the last fifteen years the number of issuers active in the market decreasing almost by a half (from 22 in 2008 to 11 in 2015).
JP Morgan is one of the top players in Hong Kong’s warrants market in terms of net Vega sold, both in 2014 and 2015. There are several other competitors active in this market as well.
Trading stocks is subjected to the Hong Kong stamp duty which is at a rate of approximately 10bps whilst investors of warrants do not need to pay it as trading warrants is exempted from the stamp duty. Is this why warrants/CBBC products are more actively traded than equity stocks by HK investors and the reason behind the recent exit of some providers?
This constitutes one of the main reasons why many investors prefer trading warrants than stocks. This business can be cost intensive if it is not well managed. As opposed to the typical structured products which are effectively placed out when clients purchase them, issuers of structured warrants issue and list products with different underlyings, maturities and strikes in order to provide a wide selection of choices for clients to choose from.
What other factors made warrants/CBBC products appealing to investors? Are they suitable for retail investors?
The liquidity provided by issuers is also often larger than the underlying market available. Together with the stamp exemption, such an environment contributes to the high daily turnover as the majority of investors make use of this environment to trade in and out as opposed to trading stocks. There is, however, a high cost in providing such liquidity.
Warrants are listed on the Stock Exchange of Hong Kong (SEHK) as opposed to the futures and options exchange. These products are primarily targeted to retail investors whereas most of the bank’s OTC activities are geared towards the private banking and institutional segment, which involves larger ticket size. These products are relatively accessible as investors do not need an ISDA agreement, margin requirements, etc. Minimum trade size requirements are very small compared with OTC products, and this in turn makes them more accessible to the retail client segment. Occasionally, hedge funds and private banks may use structured warrants for tactical trading but the main investors holding these products are retail.
CBBC was introduced in 2006. The delta of CBBC is generally close to or equal to one. Hence, this product serves as an alternate leveraged product for the investors that do not want volatility exposure.
Are there any restrictions in relation to the use of payoff types and underlyings?
At the moment CBBCs and warrants can only refer underlyings that have been approved by the SEHK. US or Japanese indices and stocks for instance can also be referenced but China A shares are not allowed yet. All underlyings have to be approved by the SEHK before they are deployed in warrants and CBBCs.
Hong Kong has less payoffs in structured warrants comparing to the European markets. But it is also a market that presents significant growing potential given its close connection with the Chinese market.
How do warrants complement the issuance of traditional buy-and-hold structured products?
These products play a very important part of the banks equity derivatives business as investors bought more than $50m Vega on average every year. Traditionally, the structured product market in Hong Kong has been dominated by structured products which bring a lot of volatility to the banks, but warrants bring balance to the investment market because they take a lot of that volatility away. If we look at other markets where warrants are not active or became inactive, the overall volatility of the market and turnover of the cash market are in general lower.
What’s the key to succeed in the warrants/CBBC market?
Not only do we place our clients’ interest as our top priority through providing liquidity and wide range of product offering, we are also focused on providing value-added products and services to our clients with transparent and competitive pricing. We conduct educational seminars for investors to increase their awareness of the risks and benefits associated with such products. We also provide an effective platform to convey comprehensive and up-to-date market information to the investor through our website. Our clients and investors recognize these which allowed us to become the top provider in this segment in a short time.
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Citi becomes latest bank squeezed out of HK warrants and CBBCs
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