ROOM FOR GROWTH IN WARRANTS MARKET

source : http://thestar.com.my/news/story.asp?file=/2007/2/1/business/16744084&sec=business

Warrants have yet to stamp a mark here even though markets like Singapore and Hong Kong saw increased derivatives trading in 2006, thanks to Asia’s bull run. Today’s first of a six-part fortnightly series explores this instrument.

Structured warrant markets in Asia underwent big changes in 2006, partly due to the buoyant regional market and the growing familiarity with the instrument.

With bullish sentiment, warrant trading now accounts for nearly 30% of Hong Kong’s total turnover compared with 7%-9% a few years ago. In Singapore, it contributes to 5%-10% of total daily turnover.

Such appetite for volatility is evident in Malaysia, despite slowed momentum since the new Securities Commission (SC) guidelines in May 2003. Bursa Malaysia shifted gears in the second half of 2006 with CIMB accelerating its warrants issuance programme, followed by AMMB and OSK Securities.

Still, the warrants market here is small and inactive - from 12 call warrants at the end of 2005 to 35 currently.
For 2007, expect to see further relaxation of listing requirements. The current placement methodology (new issues need to be placed to 100 holders, or 50 holders each subscribing to a minimum value of RM100,000) is a barrier to expanding the warrant market. .

Hong Kong and Singapore abandoned such regulations in 2001 and 2004 respectively, replacing them with the “warrant supermarket” approach where issuers list warrants and “shelve” them for public consumption.
Risk management takes effect when the warrants are consumed in the secondary market, causing an influx of warrant launches. Listing fees were lowered as an effect (not a cause) of the huge issuance supply.

Such supply-driven effects fuel structured warrant popularity. Currently, there are 20 issuers in Hong Kong and 13 for Singapore though only a few dominate the market.

They compete to issue or roll over new warrants with relevant strike levels as the market trended upwards throughout 2006.

There are 550 Singapore Exchange (SGX)-listed structured warrants, compared with Bursa's 35 (in 2003, both SGX and SC revised guidelines). Another implication is that the greater range of issuers and warrant issues will translate to depth and market making efficiency with warrants.

Prior to the current system, daily prices of structured warrants were based on supply and demand without liquidity guarantee. Nonetheless, the existing system is not foolproof. Examples include quotations of two call warrants - Resorts-CA and Genting-CA, which traded in opposite directions to their underlying stocks.
The challenge for Bursa is to induce inter-warrant competition from foreign issuers running on a global platform to improve overall market making efficiency.

Risks will increase as more issuers compete for a selective group of stocks. Any inconsistent pricing from volatility manipulation or failure to maintain tight bid-offer spreads will be quickly acknowledged by demand.
While the appetite for volatility can become more manageable on the delta- and gamma-hedging fronts, increasingly competitive supply will evolve and issuers will adopt less defensive techniques.

Bursa, the issuers and the distributing brokers are anxious to keep the warrant market moving. Thus they need investors to understand structured warrants. In Hong Kong and Singapore, warrant issuers actively provide data on warrants indicators and conduct product seminars on warrant trading.

The structured warrant market in Malaysia needs to grow. The typical buy-and-hold warrant trading strategy will only succeed with efficient market makers from a range of issuers. High delta in-the-money warrants will be replaced and rolled over fast with relevant strike levels, and issuers need not resort to defensive market making tactics (e.g. widening the spreads) and rapid implied volatility adjustments.

Otherwise, investors and traders will adopt shorter holding periods for structured warrants upon closer scrutiny of the various market-making mechanisms employed by the issuers. In markets like Singapore and Hong Kong, about 90%-95% of total turnover on structured warrants were day-trades, a result of three to four years of product adoption.

The Malaysian warrant market cannot at such an early stage implement this, where participation from day-traders prevails over actual retail clients.