Lecture Series V of Warrant Knowledge Popularization Education
□ Hosted by Shanghai Stock Exchange Investor Education Center
The creation system refers to the mechanism that some qualified institutions can increase the supply of warrants consistent with the original terms through application after the warrants are listed and traded. Theoretically, the creation mechanism has the dual functions of arbitrage and short selling, which is very important to reduce the bubbles in the warrant market and curb the extreme imbalance between supply and demand; Applied in practice, the creation of warrants began in WISCO. Since then, the controversy surrounding the creation of the system has not been interrupted. Many of them are entangled in the interests of all parties in the market, but fail to look at the current stage of the warrant market to comprehensively view this issue. This article attempts to make a deeper discussion with the readers from the background of the establishment of the system, its role and its significance for the development of the market.
1、 Origin of creation mechanism
1. The imbalance between supply and demand is the main reason for the high premium and abnormal price of warrants
The first warrant since August 22, 2005 Baosteel JTB1 Since its listing, the warrant market has attracted great attention from risk preference investors, with very active trading and huge transaction amount. Baosteel JTB1 was pulled to the ceiling price on the first day of listing in the collective auction. The next day, Baosteel's warrants opened the trading limit, and the trading volume on that day reached 2.115 billion, accounting for 14% of the total transactions of A-shares in the two cities. After many years of suspension, warrants were once again "dressed up", but their relative scarcity caused by the particularity of consideration payment for share reform has planted seeds for the hype of warrants in the future from the very beginning.
The trading characteristics of T+0, as well as the scarcity of warrants themselves, made warrants quickly become the "new favorite" of market speculation forces, and the price also began to deviate from the price trend of regular shares. In the four trading days after listing, the premium rate of warrants rose from 25% at the beginning of listing to 39%. After that, although the price of warrants fell back for a while, the trend of capital pursuit driving the premium rate of warrants to rise has become obvious. On November 17, the premium rate of Baosteel JTB1 exceeded 67%.
The premium rate of Baosteel JTB1 began to fall back only after the two warrants of WISCO were listed and the supply of warrants increased. However, in the six months after the listing of WISCO warrants, the premium rate of Baosteel JTB1 was still about 10% higher than that of WISCO. Not long before Baosteel JTB1 expired, its premium rate was WISCO JTB1 Anti superimposition. For the two warrants that are close to the trend of normal shares, WISCO JTB1 was created in large numbers, while Baosteel JTB1 was not. The continuous supply of warrants generated by the creation is undoubtedly an important reason for the difference in premium rates.
From the beginning of WISCO warrants, new share reform warrants have been listed in succession. The new warrants have increased the supply of warrants, but also increased the attention of the warrant sector, resulting in a stronger demand for warrants in the market, and promoting a more active warrant market. On December 6, 2005, the total transaction amount of the warrant market exceeded 10 billion, 1.27 times the total transaction amount of A-shares in the two cities, and the average turnover rate of warrants exceeded 100%. By June 1, 2006, the number of warrants had reached 26, the turnover rate of call warrants still reached 89%, the put rate reached 69%, and the average market premium rate also exceeded 30%. From the high premium rate and turnover rate, it can be seen that the relative shortage of supply is behind the concern of warrants. Under the high turnover rate of warrants, the frequent rise and fall of prices has become inevitable.
2. The creation of warrants is an important mechanism to curb the speculation of warrants
From August 26 to October 27, Baosteel JTB1 fell by 62%; From October 27 to the end of the month, Baosteel JTB1 rose by a maximum of 80%. The sharp rise and fall of the price caused by the speculation of warrants has brought huge risks to the market and forced new regulatory measures to be introduced in succession. On November 2, the Exchange took the measure of "suspending trading for half an hour after the market opening to warn of risks" for Baosteel JTB1, but the main funds involved in the speculation continued to attack, driving the share price and trading volume of Baosteel JTB1 higher continuously.
Afterwards, SSE investigated abnormal trading accounts and punished relevant business departments. Affected by this, Baosteel JTB1 fell for the first time after the listing of warrants, but again staged a huge shock market one day later. As a subsidiary product during the share reform, warrants are inherently unbalanced in supply and demand, and their unique leverage and T+0 trading characteristics are bound to be sought after by market funds. Therefore, in addition to the strong supervision of the regulatory authorities, it also needs to be solved through market-oriented means.
From the beginning of WISCO warrants, the Exchange timely launched the creation mechanism. On November 28, 2005, 1.127 billion put warrants created by the first 10 securities companies of WISCO were listed. The market expansion led to the decline of the warrants at the beginning of the trading, and the other warrants also weakened synchronously. The premium rate of warrants dropped significantly. The purpose of the regulators to curb excessive speculation in warrants was initially achieved. Although the speculation of some warrant varieties still occurs frequently, the role of warrant creation has been fully reflected.
The empirical test shows that the creation mechanism reduces the abnormal volatility, enhances the stability of the market, improves the pricing efficiency of warrants, and is an important mechanism to curb the speculation of warrants; In addition, the creation of mechanisms can effectively reduce the volatility of underlying stocks, expand market capacity and improve market liquidity.
2、 Significance of creating mechanism
1. The introduction of creation helps to protect the overall interests of small and medium-sized investors and rational investors
Under the creation mechanism, the cost of speculating funds maliciously speculating high rights and certificates has increased. Many investors thoughtlessly believe that the creation of mechanisms has harmed the interests of warrant holders, but in fact it is not. The value of warrants is not affected by the supply relationship, and the existence of the creation mechanism will not change the true value of warrants. Warrants have a final liquidation date (i.e. maturity date), so the state of serious deviation from the true value cannot exist for a long time, and its price will inevitably return to the intrinsic value on the maturity date.
The purpose of creating the mechanism is to curb the sharp rise and fall caused by excessive speculation. In the irrational huge fluctuations, small and medium-sized investors who follow the trend of speculation are often vulnerable to huge losses. The creation mechanism can reduce the abnormal fluctuation of the price. When the price of warrants is too high, the creation mechanism can effectively increase the supply of warrants and stabilize the excessive price of warrants; After the pricing deviation is eliminated, the founder can buy back the warrants from the secondary market and cancel them.
The warrant creation mechanism can protect the overall interests of rational investors. Rational investors, based on the judgment of positive shares, obtain leverage gains through warrant trading, or as a risk control tool, rather than blindly following the trend of speculation. The seriously overestimated warrants will increase the cost of rational investors and even exclude them from the warrant market. For example, currently all put warrants are seriously overvalued, and investors who want to avoid downside risk by purchasing put warrants will not enter the warrant market; Some of the warrants with high prices are rational investors who are optimistic about positive shares, or they can only buy positive shares, or they need to pay a much higher price than the actual value to buy warrants. A relatively reasonable price is conducive to protecting the overall interests of rational investors and restoring the original function of the warrant market.
2. The introduction of creation is an important link to make up for the lack of warrant market
In the mature options and warrants market, the market maker mechanism is a very important part. For example, the Chicago Mercantile Exchange (CME), London International Financial Futures and Options Exchange (LIFFE) and Hong Kong Stock Exchange (HKEX) all have market maker systems. One of the main functions of market makers is to calm market speculation. When the market buying and selling power is seriously unbalanced, market makers can and have the obligation to join the weak party and quickly change the market supply and demand situation. In this process, the quotations of market makers will be monitored by the regulatory authorities, and since market makers' quotations are generally based on value estimation, they can play a significant role in curbing excessive speculation that seriously deviates from their intrinsic value.
Correspondingly, when most investors in the market are long, the market makers have limited chips, so they must be able to carry out a certain degree of short trading to maintain the continuity of the transaction. The establishment of a system is an important measure to complement the missing link in the warrant market.
At present, the warrant market has already established the primary dealer system. The primary dealer plays a similar role to the market maker, that is, it has the obligation to make bilateral quotations for designated warrants, maintain market liquidity, correct the imbalance of trading orders, enhance market transparency and curb price manipulation. However, in the warrant market with extremely strong demand and excess liquidity, primary dealers are relatively weak. When the price of warrants is relatively undervalued (such as the negative premium of Valin in 2006), traders can buy warrants to guide the price of warrants back to near reasonable value; When the warrant price is overvalued, compared with the speculation power, the dealer's chips appear to be a drop in the bucket and can only allow the warrant price to continue to soar, and then return to the value in a way of plummeting.
Under the creation system, on the one hand, the founders have greater power to lead the price return; On the other hand, there will be competition and constraints between multiple creators, and the price will tend to be the same. In the case of overvaluation of warrants, if the selling quotation of a certain founder is too different from that of other competitors, its trading volume will be affected. Therefore, under the competition, the founder will report the quotation that best reflects the warrant value and market conditions as soon as possible, thus avoiding further expansion of price overvaluation.
3. The introduction of creation is conducive to a smooth transition to a mature warrant market
Generally speaking, warrants have the following three functions: hedging and risk management, arbitrage and speculation. In the above three purposes, the warrant is first used for hedging and risk management, then for arbitrage, and finally for speculation. However, only warrants with appropriate subject matter and terms and reasonable market price can be used for hedging and risk management. Therefore, judging whether a warrant market is mature can be based on whether the market can provide sufficient, diversified and reasonably priced warrants.
In the mature overseas warrant market, such as Hong Kong, Germany and other places, there are both equity warrants issued by listed companies themselves as a means of refinancing, and covered warrants issued by securities companies to meet market demand. The latter has become the mainstream of the market due to its flexibility and diversity.
In Hong Kong, for example, there are more than 2000 warrants, of which the trading volume of covered warrants accounts for about 99% of the market. In terms of target selection, the stocks available for securities companies to issue warrants cover major listed companies in most industries, such as banks, real estate, telecommunications, oil and gas; In terms of duration, the duration of warrants varies from six months to 1.5 years; The reasonable design of the exercise price and the exercise proportion makes the warrant price generally not high at the time of issuance. The flexible issuance of warrants and the huge number of warrants have given Hong Kong investors a full range of options, and also avoided the embarrassment of "focusing on several warrants in the whole market". In terms of price guidance, Hong Kong's market maker mechanism ensures that the warrant price will not deviate too far from its intrinsic value. Measured by volatility, the ratio of implied volatility of warrants to historical volatility is generally between 1.5 times and 0.5 times, which ensures that investors can always invest in warrants at a more reasonable price.
In contrast, in the mainland warrant market, when the number of warrants is the largest, there are only more than 20, only one percent of that in Hong Kong. The range of options available to investors is very small. There are only two warrants corresponding to a single underlying security. After two years of bull market, most warrants have been in or out of the deep price, and are no longer suitable for hedging and risk management. Therefore, speculation naturally becomes the dominant factor in the warrant market.
At the beginning of the opening of the mainland warrant market, investors' understanding of warrants needs to be further deepened. In the case that the issuer and supporting systems need to be improved, it is obviously not appropriate to hastily launch covered warrants. In this case, the warrant creation system launched cannot but be said to be a suitable transitional choice. First of all, the creation of institutions has played a role in curbing speculation by increasing supply; Secondly, investors gradually understand the difference between continuous issuance of warrants and "additional issuance" of stocks through the creation of systems, and have a deeper understanding of warrants; Finally, the establishment also gave a rare "training" opportunity for mainland securities companies, enhanced their risk control ability, and laid a good foundation for the future issuance of covered warrants.
3、 The Regret of System Absence -- Experience and Lessons at Home and Abroad
1. Summary of Domestic Warrant Market Experience -- Unequal Game
"Baosteel JTB1" expired on August 22, 2006. As the first share reform warrant, the first expired warrant, and the warrant that has never been created, the trading process of Baosteel's warrants is fully "typical" to reveal the market ecology of the domestic warrant market.
According to the average daily trading amount, the investors of Baosteel Warrants are divided into large (trading amount exceeds 500000 yuan), medium (trading amount is between 100000 and 500000 yuan), small (trading amount is between 10000 and 100000 yuan) and retail (trading amount is less than 10000 yuan). According to the statistical report completed by the Innovation Laboratory of Shanghai Stock Exchange after the expiration of Baosteel Warrants, the average profit of large investors is 247000 yuan, The average profit of medium sized investors is 25000 yuan, while small and retail investors generally lose money. The profitability of large investors is much higher than that of small and medium-sized retail investors. The yield results clearly show the power contrast of various roles in the warrant market. Compared with large investors, small investors and retail investors are absolutely weak.
Another report released by the SSE, entitled Analysis of Trading Behavior in the Warrant Market, further revealed the trading behavior of various accounts in the warrant market. During the four weeks from June 5 to June 30, although the number of accounts of large accounts only accounted for 2% of the total, their trading amount accounted for 62% of the total amount of the warrant market. In contrast, the trading volume contributed by small investors is 15%, and the trading volume of institutions and retail investors is less than 2.5%. From the perspective of operation techniques, 80% of large investors generally conduct more than 10 transactions every week, making full use of the trading characteristics of warrant T+0, while nearly 40% of retail investors only trade once a week.
Obviously, in the money arena of warrant investment, the big players have firmly occupied the dominant position in the game. Whether from the perspective of the amount of funds, operation techniques, or the ability to influence the market, the big players have been in absolute strength; However, due to the serious imbalance of power, small and medium-sized retail investors are obviously in the following position in the warrant market. When the warrant price rises, they can only catch up passively, and when the price falls, they have to bear losses.
When market forces have become seriously unequal, price manipulation becomes inevitable, and the price discovery function of the market is even more impossible to talk about. In this case, it is necessary to balance the market and guide the price return. In the unilateral long market, the primary dealer's innate weakness of "holding down the decline but not holding down the rise" has led to its inability to take on such an important task. In this context, the warrant creation mechanism has to be pushed to the front as a "firefighter". In the future, only when the issuance and additional issuance mechanisms are gradually improved and the market supply is sufficient can the warrant market develop healthily and orderly.
2. Experience of Overseas Warrant Market for Reference -- Dispute over the "Additional Issuance" System of Hong Kong Warrants
Before 2002, the Hong Kong warrant market had imposed restrictions on the total issuance of derivative warrants, requiring that the total issuance of derivative warrants should not exceed 20% of the total issued underlying securities or 30% of the public holdings. However, in practice, due to the limitation on the amount of issuance, the issuer's ability to issue additional warrants has been limited. The imbalance between supply and demand often leads to the abnormal price of derivative warrants. Once the warrants deviate from their theoretical value by a large margin, investors who buy at a high price will suffer great losses. Therefore, based on extensive market consultation, the Hong Kong Stock Exchange abolished the quota system in 2002, allowing issuers to issue more warrants after selling more than 80% of the issued warrants, so as to increase market supply and balance supply and demand.
On August 18, 2005, the Hang Seng Index dropped 301.49 points. The decline of the market led to the diving of subscription certificates, which caused heavy losses for many investors. The warrant system has once again triggered a great discussion among all sectors of Hong Kong about the development of the Hong Kong warrant market, and some investors have asked the management department to re-examine the "additional issuance" of warrants and other systems. Therefore, the Hong Kong Stock Exchange and the CSRC have issued advisory reports on issues of concern to investors in order to seek opinions from all parties in the market.
For the issue of whether the restrictions on the issuer's additional issuance should be restored. Some investors proposed that unrestricted additional issuance would lead to excessive supply, which would make the price of warrants too low and hurt investors. This view is reasonable at first sight, but it is not recognized that it is the positive shares that ultimately determine the trend of warrants, and the additional issuance only promotes the price of warrants to return to its intrinsic value. After analyzing the historical experience of the Hong Kong warrant market, the Hong Kong Securities Regulatory Commission and the Exchange believe that restricting additional issuance will only lead to greater price imbalance and ultimately damage the interests of investors. Based on this, in order to reduce the chance of short-term anomalies in warrant prices, the final measure is to improve the efficiency of additional issuance by shortening the time for additional issuance acceptance and other measures,
At present, Hong Kong Stock Exchange takes 4 days to accept the application for additional issuance of warrants. During this period, the market may still encounter a situation of supply falling short of demand, causing a sharp rise in the price, while the price of newly issued warrants will fall back after listing. The Hong Kong Stock Exchange and the Securities Regulatory Commission both believe that the restrictions on issuance should be further reduced to reduce market changes. Specific measures include: shortening the processing time of additional issuance applications from the original four days to two days, so that issuers can complete additional issuance more quickly, and raising the upper limit of the current additional issuance conditions by 20%; Provide convenience for different issuers to issue the same warrants, promote competition between different issuers, and reduce the possibility of monopoly and manipulation.
It can be seen from the suggestions of the Hong Kong Stock Exchange and the Securities Regulatory Commission that the "additional issuance" system is essential to maintain the reasonable pricing of the warrant market. A convenient and effective "additional issuance" system and competition between different issuers will help reduce the irrational volatility of the market and promote the healthy development of the warrant market. At present, the acceptance time of warrant creation of SSE is one day. The higher creation efficiency more effectively curbs the excessive volatility of warrants and reduces the probability of investors being locked up at unreasonable high positions. In this process, whether or not to create and cancel, and the number of creation and cancellation are all market behaviors independently decided by the creator, while the exchange only undertakes the business processing function, not the approval function. Such institutional arrangements are also conducive to improving market efficiency and protecting the interests of investors.
4、 Detailed explanation of key issues
1. Will the creation cause substantial fluctuations in the prices of warrants and equity shares?
At present, the creation of warrants adopts the full amount mortgage system. According to the provisions of the Notice on Matters Related to the Creation of Warrants by Securities Companies, when creating warrants, the creator needs to fully mortgage the underlying securities used for exercise in the registration and clearing company; When creating the put warrants, the creator needs to pledge the cash used for exercise in full until the created warrants are cancelled or expire. Therefore, after selling the warrants, the founder does not need to use the positive share adjustment method to hedge the risk of warrant issuance, and will not affect the positive share trend.
The creation of warrants is mainly a speculative restraining measure against the overvaluation of warrants. When the price exceeds the reasonable value by a large amount, the warrant price is controlled to continue to rise by selling warrants, and when the price returns to near the reasonable value, the warrant is bought back and cancelled. Therefore, the creation of warrants is objectively a process of reducing the volatility of the warrant price, and will not lead to or amplify the volatility of the warrant price.
2. Should there be a minimum duration limit for creation warrants?
The creation of warrants should not have a minimum duration limit, otherwise, when the remaining duration of warrants is shorter than the minimum duration, warrants cannot be created, and the total flow flux is fixed, which may be subject to speculation. The absolute price of out of price warrants is low when they are nearing maturity, and the fluctuation range is large. If the circulation is also low, it is very suitable for the operation of speculation funds. If the minimum duration of warrants is set, speculation funds will enter the market when the remaining duration of warrants is less than the minimum duration to speculate on warrants. Because it cannot be created, the supply of warrants is fixed, and the price will rise sharply under the promotion of funds, attracting more small and medium-sized investors to follow up, which will make small and medium-sized investors face huge risks and damage their interests. If there is no minimum duration limit for the created warrants, when speculation funds flow in, the newly created warrants can play a role in curbing price inflation, thus maintaining the warrant price near the theoretical value. The creation of a mechanism has a deterrent effect on speculation of funds, can also prevent small and medium-sized investors from blindly following the trend of speculation, and maintain the normal order of the warrant market.
From the experience of mature markets, the newly added warrants should not have the minimum duration limit. Taking Hong Kong as an example, Article 38 of Chapter 15A of the Hong Kong Stock Exchange Securities Listing Rules clearly stipulates that initial listing warrants should have a minimum duration limit, but re issued warrants do not need to meet the minimum duration limit. If the issuer thinks it is necessary to re issue, it shall apply to the Exchange for re issuance. After the Exchange approves the issuance application, the issuer can re issue the warrants with completely consistent terms, without being subject to the minimum duration. The Interim Measures of the SSE for the Administration of Warrants also stipulate the minimum duration of warrants when they are initially listed, while there is no limit on the duration of warrants created. This regulation is in line with international practice and has played an obvious role in curbing the excessive speculation of warrants.
Speculation funds are keen on chasing out of price warrants with small flow, low absolute price and near maturity. Under the current circumstances, if the shortest deposit and renewal period of the creation warrants is set, speculative funds will increase, causing sharp rise and fall of warrant prices, which will have a negative impact on the healthy development of China's derivatives market.
3. Will the founder manipulate the warrant price?
The founder will not manipulate the price of warrants: first, the internal management system of securities firms eliminates the possibility of price manipulation from the source; Secondly, the supervision of the exchange and the securities regulatory authority has curbed the price manipulation in the external system; In addition, through the analysis of the trading banks in the warrant market, it can also be seen that there is no phenomenon of the creator manipulating the warrant price.
The founders of warrants are all securities companies with standard operation and good qualifications, and have strict internal control system. The creation of warrants is not risk-free arbitrage, so there are certain requirements for the risk control level, operation level and net capital of the founder. So at present, only a few high-quality securities companies can create warrants. These high-quality securities companies themselves have good internal management systems and risk control systems, and it is impossible to jointly manipulate the price of warrants. In addition, the Exchange pays close attention to the accounts with active transactions. For some accounts with abnormal transactions, the Exchange gives risk warnings or restricts transactions. The corresponding securities regulatory authority also strictly supervises the founder's trading account. Under the joint control of securities companies, exchanges and regulators, there will be no phenomenon of the founder manipulating the price of warrants. Price manipulation is a serious violation of the securities law. The founder is an important participant in the securities market, and it is impossible to operate illegally at the risk of violating the law. Therefore, in terms of system, it is impossible for the founder to manipulate the warrant price.
According to the warrant market trading data released by the Exchange, the proportion of institutional customers in the trading volume is very small, and most of the trading volume comes from large individual investors. The trading volume of institutional customers simply cannot reach the level of price manipulation, and the founder did not manipulate the market price. The creation of warrants is completely a market behavior. When the warrant price deviates from the theoretical value more, the creator will create warrants to curb market speculation; In the case that the warrant price becomes more rational, the creator will cancel the created warrant.
4. Can the Founder and Warrant Investors Win Win?
The founders and investors can achieve a win-win situation: by providing liquidity, the founders can maintain the market price within a reasonable range and ensure the smooth transaction; Investors can select appropriate warrant varieties for risk management according to their own risk positions, or conduct directional investment based on the judgment of the future market, so that both parties can achieve a win-win situation.
Creation can restrain excessive speculation and protect the interests of rational investors. Warrants have many functions, such as risk management, leveraged investment, etc. But the premise is that the price of warrants should be near the theoretical value, so that investors can buy warrants at a reasonable price level. The recent excessive speculation on put warrants is driven by speculative funds, resulting in a serious deviation from the theoretical value of warrant prices. The massive influx of speculation funds has led to a sharp rise in the price of warrants, which has led to the inability of real demanders (such as risk dodgers) to invest in warrants. When the warrant price deviates from the theoretical value by a large margin, the creator will provide the circulation of the warrant, thus promoting the return of the warrant price to the theoretical value. The international warrant market usually adopts the market maker system to provide circulation for warrants. The creation system is similar to the market maker system, both of which can provide circulation, thus inhibiting excessive speculation and providing some protection for investors.
(Author: Zhong Xin)
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