An Analysis of the Impact of Warrants on China's Stock Market

Source: United Securities

　　 The interim measures for the management of warrant business still need to be improved, but the transaction of n warrants and equity shares will be very active for the development of the warrant market, which is conducive to market development, and other stocks may be left out in the cold

Warrants will bring underwriting income, proprietary income and a large number of fees to securities companies, and together with private funds, they will become a warrant market

If the management measures are relaxed, the warrants will promote the realization of the value of convertible bond options

In the warrant share trading scheme, the minimum consideration is generally determined by means of stock dividend and warrant resale. Warrants, as the change part of the consideration, are handed over to the market for future settlement. Some companies also combine the reduction and refinancing of major shareholders

It is rumored that Baosteel's call+put warrant scheme provides more protection for circulating shareholders when the share price falls. The principal guaranteed price of circulating shareholders is lower than that of non circulating shareholders, but the final result may be a double loss

The warrant scheme is equivalent to the reduction of the net assets of major shareholders, and can also provide some protection if it is supplemented by the sale back

The call warrant scheme is equivalent to allotment of shares, which has the least protection for circulating shareholders, is suitable for growth companies with clear investment direction of funds and can clearly generate profits. Whether they are covered warrants or equity warrants, if they are settled by shares, on the one hand, they will increase the circulation of shares and cause the stock price to drop due to the ex right effect, on the other hand, the value of European style warrants is not as good as that of American style warrants, Both are unfavorable to circulating shareholders and will cause great pressure on individual shares and the market, which should be restricted

Warrant schemes can be converted into the range of consideration expressed by stock dividends. Investors can determine their own opinions and make decisions according to the range of consideration, specific terms of warrants and company fundamentals

Recently, Shanghai Stock Exchange and Shenzhen Stock Exchange have successively introduced the interim measures for the management of warrant business, which indicates that the pace of the Exchange's introduction of warrants is accelerating. In the special environment of China's securities market, warrants have been given a new function to solve the split share structure, which is an innovation that no securities market has ever tried. Whether this innovative product with Chinese characteristics can bear the heavy responsibility of the split share structure reform, and what kind of plan China's warrant market will develop towards, are also the problems that must be solved in the long-term development of China's warrant market. Therefore, before many expectations are clear, warrants are a double-edged sword in China's securities market. If they are used well, they will make contributions to the split share structure reform and make great progress, which will benefit the overall development of the securities market; If it is not used well, it will have a negative impact on the split share structure reform. It is possible to repeat the fate of warrants in the 1990s and be put back in the cold for a long time without development.

　　 1、 The Interim Measures for the Management of Warrant Business still need to be improved, but it opens the way for the development of the warrant market

The Interim Measures for the Management of Warrant Business introduced by the Exchange is similar to the provisions of the Hong Kong Stock Exchange on warrants in form but not in spirit, which shows that the Exchange has insufficient understanding of warrants as a derivative product and insufficient confidence in supervision. This is reflected in the following aspects: the entire management method does not distinguish between the equity warrants issued by listed companies and covered warrants issued by third parties (such as brokers, major shareholders, etc.), and the two types of warrants with different nature and functions are managed by one management method; There is no explicit provision on the qualifications that warrant issuers should possess; In order to reduce the cost of supervision, it is not clear to give the issuer of covered warrants the qualification of market maker. In general, the temporary management measures are poorly designed. What the designers want is the share trading reform, but the management measures written out should cover all types of warrants, so it is difficult to cover all aspects, and some loopholes are inevitable.

The lower limit of warrant duration (three months) specified in the management measures is too short. From overseas experience, the duration of equity warrants is generally at least one year, and covered warrants are at least six months. The SSE allows the issuance of warrants with a duration of three months, and does not specify the difference between capital stock and reserve. If the duration of equity warrants is so short, it will increase the pressure on market expansion, which is not conducive to market stability. The short duration of warrants may also cause significant fluctuations in warrant trading or poor liquidity, mainly because warrants are a new product and ordinary investors need some time to become familiar with them. In addition, too short duration also makes it possible for some market participants to manipulate the price of warrants.

Generally speaking, the settlement price of the underlying securities is determined by the warrant issuer according to the market conditions. In some cases, the average closing price of the underlying securities in the previous five trading days or the average price in the previous one to three months is taken. The management measures clearly stipulate the settlement price, which can only take the median of the underlying closing price of the previous five trading days. The author is worried that such a clear provision will provide manipulation space for warrant trading, and the manipulator only needs to manipulate the closing price of the underlying securities on the last five days.

The Administrative Measures stipulate that the reference price for the opening of warrants on the first day of listing shall be calculated by the issuer and submitted to the Exchange for confirmation. Due to the lack of standard pricing model of warrants in China at present, it is difficult to have a strict definition of whether the reference price for the first day opening of warrants is reasonable, so the pricing difficulty of warrants may also cause the price of warrants to rise and fall sharply after listing.

Any market will inevitably be manipulated. It is unrealistic to try to eliminate manipulation through a management method. Therefore, the regulatory capacity of the exchange is crucial to the healthy development of the warrant market.

　 2、 The trading of warrants and positive shares will be very active, which is conducive to market development

The warrant is essentially a financial derivative instrument, whose value is based on the value of the subject matter, and has the leverage and risk hedging function of fighting big with small. The nature of warrants is very attractive to investors. For example, suppose that the current price of a stock ABC is 10 yuan, and the price of a European warrant with ABC as the underlying and exercise price of 10 yuan is 0.5. An investor has 10000 yuan to purchase 1000 shares or 20000 warrants. Assume that the share price of ABC will rise by 20% when the warrant expires. If the investor buys stocks, he will gain 2000 yuan; If the investor purchases warrants, the profit will be 40000 yuan (2 yuan for each warrant). After deducting 10000 yuan from the cost of purchasing warrants, the net profit from the warrants will be 30000 yuan. On the other hand, if the share price falls, investors will lose all the costs of purchasing warrants of 10000 yuan. When investors are short of stocks, they can choose to buy put warrants. When the stock price is lower than the exercise price, they can exercise the put warrants to gain profits; When investors are bullish on stocks, they can buy warrants. When the stock price is higher than the exercise price, they can exercise warrants to gain profits.

In addition, as a hedging tool, warrants will also attract the attention of many investors (especially institutional investors). For example, suppose a fund company owns a heavy position stock, and a securities firm just issues put warrants with the heavy position stock as the underlying stock. If the fund company is worried about the decline of the stock price of its heavy position, it can lock in the income by purchasing put warrants. Therefore, risk averse investors will have a large demand for warrants.

The Interim Measures for the Management of Warrant Business has also made relevant provisions for warrant trading, stipulating that T+0 is applied to warrant trading, and the warrants purchased on the same day can be sold on the same day, and the warrants purchased on the same day can be exercised on the same day. The provisions on the rise and fall limit of warrants are also relatively loose, which ensure that warrant trading has strong liquidity and volatility. It can be seen that if the warrants can be restored to their true colors and the warrants can give full play to the characteristics of their derivatives, the warrant products will certainly be able to activate market transactions and inject new vitality into the current depressed securities market.

Warrants will also activate the trading of corresponding stocks. If a certain stock issues warrants, it will attract funds and increase the trading volume of stocks; However, as the management measures stipulate that the listed companies issuing warrants are all large companies, the issuance of warrants will activate the transaction of large cap stocks. In the past, small cap stocks and low price junk stocks were partly due to high volatility, but the volatility of warrants will be far greater than stocks, and the attractiveness of small cap stocks and low price junk stocks will decline.

In addition, in the short term, due to the active trading of warrants and corresponding stocks, the overall capital of the market will be under pressure, and the rest of the stocks may be greatly affected.

　 3、 The introduction of warrants will greatly benefit securities companies and change the current pattern of market participants

The management measures do not limit whether covered warrants issued by securities companies or equity warrants issued by listed companies, but they all need securities companies to participate in the issuance, and securities companies obtain underwriting income, and covered securities companies issued by securities companies may also become market makers to obtain proprietary income.

From the experience of the Hong Kong market, the active trading of warrants can bring a lot of commissions to securities companies and become an important source of income for brokerage business. In 2004, the average daily turnover of Hong Kong stock market was about 15.9 billion Hong Kong dollars, an increase of about 53% compared with 10.4 billion Hong Kong dollars in 2003. The growth of warrant market is far faster than that of the whole market. In 2004, the daily average transaction of warrants was about HKD 2.08 billion, an increase of about 91% compared with HKD 1.08 billion in 2003. The daily average transaction of warrants accounts for 13.1% of the whole market, and the highest single day transaction accounts for 25.1% of the whole market!

Due to contractual restrictions, the participation of securities investment funds in the transaction of financial derivatives will be greatly restricted. It is expected that their participation will also be due to the passive holding of the split share structure reform, and they will also face the problems of warrant pricing and net worth estimation (if the warrants are not listed for trading). It is expected that the main participants in the warrant market are securities companies and private equity funds, which will effectively promote the development of securities companies and private equity funds and change the situation of independent support of funds in the current market.

　　 4、 Warrants may promote the realization of convertible bond option value

At present, the convertible bond market has a large scale, but the option value of convertible bonds has not been fully reflected. The market price of convertible bonds is mostly lower than the sum of the bond value of convertible bonds and the option value. The reason is that, except for the A-share market, which has been depressed and the stock price has risen or fallen more, options and bonds are tied together. If you want to obtain options, you need to buy bonds, and the demand for options is suppressed, It is also an important reason.

The Administrative Measures stipulate that the warrant issuer shall provide and maintain a sufficient number of underlying securities through a special account. For companies that issue convertible bonds and have entered the conversion period, the convertible bonds can be converted into shares at any time, which is essentially equivalent to the equivalent of the underlying securities. In theory, it can also be used as the underlying securities to guarantee the performance of the contract. If the convertible bonds can be used as the underlying securities of performance guarantee, the issuer can issue warrants while holding the convertible bonds, and the exercise price can be set as the conversion price of the convertible bonds. If the warrant holder exercises the warrants, the issuer can immediately convert the convertible bonds into shares and sell them to the issuer. If the share price has not reached the conversion price all the time, the warrants will automatically become invalid when they expire, and the issuer can always hold the convertible bonds to repay the principal and interest when they mature.

In this way, when the issuer holds the convertible bonds, it first obtains a cash income by selling the warrants. In essence, it splits the bond value and option value of the convertible bonds. After the warrants are split out, the net investment required for unit options is greatly reduced, which will be conducive to the realization of the value of convertible bond options.

　　 Analysis of warrant share trading scheme and its impact on the market

Large uncertainty factors in warrant share trading scheme

The original intention of the Exchange to launch warrants is to create conditions for the split share structure reform. The first warrant product is likely to be accompanied by the pilot company's split share structure reform plan. The biggest feature of warrant schemes is that the "rights" in A-share rights are handed over to the market to determine their value. On the one hand, this can be seen as the advantages of such schemes. On the other hand, this feature may also become the disadvantages of the schemes when there are many uncertainties in the market, especially when the warrant market has just been established and is not yet perfect.

At present, it seems that as a part of the share trading scheme, the warrant guarantees the minimum consideration of the scheme in accordance with the scheme of share bonus, share reduction and sale back. The warrant, as a variable part of the consideration, or carries out financing and realization at the same time, is difficult to understand the scheme, which may cause great confusion and controversy in the market; There is also the possibility of rejecting the plan because the circulating shareholders cannot understand the warrants.

Warrants can also be used as an incentive tool for the management of listed companies to give a certain number of warrants to the management. When the stock price rises, the management of listed companies can obtain a certain amount of income, thus enhancing the motivation of the management of listed companies to do a good job in company management and improve the stock price.

　　 At present, the warrant share trading schemes popular in the market include:

1. Call warrant+put warrant scheme

It is said that Baosteel plans to adopt the warrant scheme, with one share for every 10 shares+two call warrants and five put warrants for every 10 shares. The exercise prices of the call and put warrants are RMB 4.18 and RMB 5.12 respectively. The major shareholder Baosteel Group will pay the shares of the call warrants to the warrant holders, and the major shareholder will pay the put warrants in cash according to the market price difference. The relationship between the value of this compound warrant and the stock price and its impact on the interests of circulating shareholders and non circulating shareholders are as follows:

Table: Results of Call+Put Warrant Scheme

After the implementation of the plan and the full circulation of non tradable shares, when the share price is between 3.5-5.5 yuan, the return of the warrants included in each share is between 0.188 yuan and 0.81 yuan. When the share price falls, the cash paid by major shareholders increases, and the put warrants provide a compensation mechanism for investors, partially offsetting the loss of share price decline; When the stock price is positioned higher, the value of put warrants will decline, and the consideration provided by major shareholders will be less.

From the perspective of the interests of various shareholders, when the stock price is more than 3.9 yuan after full circulation, the original circulation shareholders will not suffer losses, and the market value and the comprehensive value of warrants are higher than the original ones; For major shareholders, when the share price is below 4.18 yuan after the expiration of warrants, the market value will be lower than the original total net assets (about 4 yuan per share after additional issuance), and the major shareholders will lose money; The stock price is more than 4.3 yuan, and the market value after the stock dividend is higher than the original net assets, which benefits the major shareholders. Moreover, due to the role of warrants, the higher the share price, the faster the profit of circulating shareholders will rise than that of non circulating shareholders, and the lower the share price, the slower the loss of circulating shareholders will increase than that of non circulating shareholders. From these aspects, the scheme is more conducive to circulating shareholders.

The current scheme is that the warrants can only be exercised after one year, and 20% of the outstanding shares will be increased after one year, with a cost of 4.18 yuan. This will put great pressure on the stock price within one year. If the stock price cannot be significantly higher than 4.18 yuan at that time, Baosteel Group's idea of reducing its shares through warrants may fail, and it will also need to pay a lot of cash for put warrants, The circulating shareholders also did not benefit, which is likely to be a lose lose situation.

The essence of put warrants is forward cash compensation. The major shareholders expect the stock price to rise when the warrants are exercised, so they do not have to pay the cash spread and pay as little consideration as possible. If the put warrants can be settled by shares, that is, they can be sold to the major shareholders at the exercise price, which will reduce the market circulation and benefit the stock price and the circulating shareholders.

Call warrants+put warrants are suitable for companies with large shareholders who have strong financial strength and are optimistic about future stock prices.

Calculation of consideration range: the closing price of Baosteel before the pilot project was 4.89 yuan. If the stock price is automatically ex right after 10 shares are given out, the stock price will become 4.445 yuan, the return on call options will be (4.445-4.18) * 2=0.53 yuan, the return on put warrants will be (5.12-4.455) * 5=3.375 yuan, and the total return on the two warrants will be 3.905 yuan, equivalent to 0.88 shares; In general, the consideration range can be converted into 1.88 shares for 10 free.

　　 2. Call warrant+put back

It is rumored that one of Sinochem International's plans is that the major shareholders will issue four warrants for every 10 shares to the circulating shareholders at an exercise price of 3.2 yuan, and the circulating shares can sell back the warrants at a price of 2 yuan per share to the major shareholders.

The warrants issued by major shareholders are mainly European warrants, which can only be exercised at the end of the warrant period. If the exercise price is near net assets, it is a copy of the previous reduction of net assets, which will bring pressure on stock price expansion; The value of each warrant obtained by the circulating shareholders under the put back clause is at least 2 yuan, which provides certain protection for investors when the share price drops.

The main factors determining the value of the warrant are:

A Exercise price: if the exercise price of the warrant is high, it is beneficial to the non tradable shareholders and unfavorable to the tradable shareholders; Low exercise price benefits circulating shareholders

B Exercise time, that is, European style warrants or American style warrants. European style warrants are low in value, which is beneficial to non tradable shareholders, while American style warrants are high in value, which is beneficial to tradable shareholders

C Put back clause: if there is a put back clause, that is, the circulating shareholders can sell the warrants back to the major shareholders at a certain price, which is beneficial to the circulating shareholders. The higher the put back price, the better

Calculation of consideration range: Sinochem International's current share price is 5.58 yuan. If the share price remains unchanged, each warrant is worth 2.38 yuan, and four warrants for every 10 shares are worth 9.52 yuan, which is equivalent to the consideration range of 1.7 shares for every 10 shares. If the share price falls, each warrant is worth at least 2 yuan, which is equivalent to the consideration range of 1.43 shares for every 10 shares.

　 3. Share warrant scheme:

It is rumored that Changjiang Power plans to adopt the equity warrant scheme, with 0.5 shares for free for 10 shares and 2-3 share warrants (issued by listed companies), and the exercise price is 5-7.6 yuan

The characteristic of share warrant is that the share warrant issued by the listed company is added on the basis of share allotment, and the circulating shareholders can buy shares from the listed company at the exercise price, which is essentially equivalent to share allotment. Equity warrant is combined with refinancing, which breaks the limitation that refinancing needs to be approved, but there is a great suspicion of money circling, which needs to be approved by the management.

For the equity warrant scheme, once the stock price falls, the value of the warrant will fall rapidly, and the circulating shareholders will receive less protection than the above two schemes.

The warrant scheme is suitable for growth companies, and the capital obtained from share allotment has good investment projects, which can bring considerable returns to the company and shareholders, so that it may be recognized by circulating shareholders.

Calculation of consideration range: assuming that 2 warrants are distributed for every 10 shares, the exercise price is 5 yuan, and the automatic ex option price is 7.78 yuan after 0.5 yuan is distributed for every 10 shares, the value of each warrant is 2.78 yuan, and the value of every 10 stock certificates is 5.56 yuan, which is equivalent to 1.21 shares for every 10 shares.

　　 Conclusion:

We believe that if the warrant is settled by shares and the major shareholder or listed company transfers shares to the circulating shareholders, it will be quite unfavorable to the circulating shareholders:

1. The call covered warrants are similar to the reduction of net assets, the call equity warrants are similar to the allotment of shares, and the circulating shareholders need to pay a large amount of cash. At present, the market is short of funds, and there will be great opposition to the money ring, which will lead to the decline of stock prices and affect the value of warrants

2. There may be an ex right effect, and the stock price will automatically fall, and the warrant value will also be discounted

3. The opinion on the split share structure reform stipulates that the major shareholders shall not circulate or transfer within one year after obtaining the circulation right. If the major shareholders of the warrant scheme settle with shares, the warrant period will be more than 12 months, and only European style warrants can be used, which reduces the value of the warrants and is easy to cause stock price manipulation. The major shareholders may manipulate the settlement price. In addition, if the warrants cannot be listed, it is also bad for the circulating shareholders if the consideration cashing period is too long.

Therefore, we believe that if the warrant in the warrant type share trading scheme adopts stock settlement, it will pose great pressure on individual shares and the market, and violate the principle of not circling money formulated at the initial stage of the share trading scheme, which will cause great controversy, and its application should be strictly restricted; If cash settlement is adopted, there is no pressure on the market to expand, which is relatively favorable.

　 Countermeasures:

For the warrant scheme to be launched in the future, we can first determine the amount of consideration outside the warrant (stock dividend and stock reduction), and then use our similar calculation process above to calculate the amount of consideration converted from the warrant itself to the stock dividend, and then sum up to get the total amount of consideration; Then, according to the specific terms of the warrant and the company's fundamentals, judge whether the consideration range is reasonable, and put forward corresponding opinions and make decisions.