Regulators in Hong Kong are mulling over the introduction of inline warrants as issuers eagerly wait for the greenlight.
The product launch on the Hong Kong Exchanges (HKEX) is long-awaited by the banks that issue other types of listed structured products in the region such as derivative warrants and callable bull/bear contracts (CBBCs). Major players include Societe Generale, UBS, JP Morgan and Credit Suisse.
“If you look at the Hong Kong market, there are two product types listed – warrants and CBBCs,” said a senior executive at a foreign investment bank in Europe. “This is quite a peculiar situation compared to securitised derivatives markets elsewhere. In Europe, typically, there is a much wider range of product types listed as well as the underlyings.”
If launched, the new product type is expected to boost market activity as it will mark the first listed structured product since mid-2006 when CBBCs were introduced in Hong Kong.
“The turnover volume for warrants and CBBCs have accounted for 20 to 25% of total market turnover quite consistently in the last eight to 10 years,” said a head of listed distribution at one of the major warrant and CBBC issuers in Hong Kong. “So, as investors are becoming more mature, it will be good to see a new product in the market.”
HKEX is in talks with structured product issuers on the possible introduction of inline warrants in consultation with the Securities and Futures Commission (SFC), said a spokesperson at HKEX.
Difficult bet
Inline warrants have been available in Germany for several years but they are still a niche structure. German exchanges represent the largest market for the products in Europe.
“It’s probably more natural for retail investors to trade call and put, or on upward or downward moves of the market, instead of betting on stability like inline warrants do,” said Fabio De Zordo, head of structured, securities and flow products at Unicredit. The bank is one of the biggest issuers of inline warrants in Germany.
The product works well when market volatility is low as seen in 2017 and at the beginning of last year. However, it is generally very difficult for ordinary retail investors to predict a certain price range of an underlying asset, not to mention how much more difficult it can become during uncertain times like now amid the trade war and Brexit. Because the products are listed, individual investors are the main buyers of the products.
Unlike derivative warrants, the value of inline warrants does not decline over time, or closer to the maturity date. Understanding such feature is crucial for retail investors to trade the product.
“The buyer of the product is theta long, meaning the product is gaining value as it approaches maturity date,” said Fabian Ecker, equity derivatives trader at Unicredit. “For the Hong Kong market, this is a completely new feature, which is also relatively uncommon in European markets.”
Daily leveraged certificates (DLCs), another type of structured product listed on the Singapore bourse, also share the same attribute. For issuers, this so-called ‘no time decay’ feature can be a good fit in their books as different type of products with different risk profiles can offset the risk exposure of each other.
While inline warrants are yet to set foot in Hong Kong, the turnover volume for the products in Germany came in at around €350m (US$394.4m) last year for equity underlyings, across 125,000 trades, according to Unicredit.
“Such strong turnover can be attributed to the fact that investors there are particularly well-educated in private investor products,” said Ecker.
Unicredit has issued around 10,000 inline warrants on equity indices and stocks and is now looking into precious metals and oil in the German market.
The SFC declined to comment.
An inline warrant is an option with two barriers – an upper and a lower barrier. Investors will profit if neither levels are breached through the product maturity. Investors bet on the price range of the underlying asset that could be a stock or an index.