By Wang Lan (China Daily)
Updated: 2007-09-13 13:34

In little more than two years since the first stock warrant was issued, the Chinese mainland has overtaken Hong Kong as the largest warrant market in the world by turnover.

According to data compiled by Shanghai Stock Exchange Infonet Co Ltd, warrant turnover on the Shanghai Stock Exchange amounted to 2.7 trillion yuan (US$358 billion) in the first six months of the year, accounting for 16 percent of the aggregate trading volume on the bourse.

Warrants allow investors the right to buy securities at a specific future time at a price fixed at the time of issue. Before maturity, the instrument is traded on the stock exchange.

Because of the relatively low transaction cost compared with trading shares, warrants are attracting an increasing number of individual investors, especially after stamp tax was raised on May 30.

A rule allowing investors to sell warrants they bought on the same day has also helped increase warrant turnover by attracting short-term capital and speculative funds at a time when the stock market is clouded by policy uncertainties.

Shanghai Stock Exchange statistics show that trading in warrants increased 75 percent to an aggregate 329 billion yuan in the week after the stock price plunge on May 30 after stamp duty was raised.

Despite its growing popularity, analysts say the mainland warrant market is being hobbled by restrictions on covered warrants, which are usually issued by banks and other financial institutions against their large holdings of the underlying stocks. Financial experts have long held that issuing covered warrants is crucial to the development of the mainland's warrant market.

It will be difficult for the mainland's warrant market to continue its current growth momentum unless covered warrants are issued in the near future," said Zhang Biao, manager of the derivatives department of Guotai Jun'an Securities.

Unlike traditional bank-issued covered warrants - such as those traded in Hong Kong, Singapore and the rest of the world - the mainland's warrant market has developed from the stock reforms of large listed companies including Shanghai Baosteel, China Southern Airlines and Shenzhen Vanke.

Covered warrants, which are issued by qualified financial institutions, provide a wider source of warrants and help balance the supply and demand of the warrant market.

The Shanghai and Shenzhen bourses started with 40 warrants, compared with more than 2,000 warrants in Hong Kong. Now, as many of those warrants have matured in the past two years, only 21 warrants remain on the two bourses. The number of listed warrants has dropped to eight from 26 in Shanghai.

Warrant prices have been pushed up to levels that are largely out of sync with their underlying stocks because of short supply, analysts said.

Liu Xiaodong, executive vice-president of the Shanghai Stock Exchange, said the mainland warrant market is in urgent need of new warrants to meet strong demand from investors.

"The prospective issue of covered warrants will expand supply and make prices more reflective of share prices," said Teng Tianming, executive vice-president of China Asset Management Co Ltd.

The warrant market could also play a role in guiding the development of other derivatives products, given their similarities, analysts said.

"Individual investors are trying a different trading mechanism from that of the stock market (by investing in warrants)," said Wang Jizhong, managing director of Everbright Securities' financial derivatives department. "The warrant market has sped up progress on establishing a derivatives market on the mainland."

"Institutional traders have learnt from the warrant market how to handle the higher risks of derivatives trading," said Liu Xiaodong.