Covered Warrants I

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9. UK warrant market

Regulatory development

The Financial Services Authority (FSA) belatedly realised that London needed to compete internationally and that it was unreasonable to prevent UK retail investors from investing in covered warrants. The FSA therefore introduced new rules to facilitate the listing of covered warrants as part of its objective to "seek to maintain the competitiveness of the UK markets for listed securities".

In late June 2002 the FSA published its new rules governing the listing and conduct of business for securitised derivatives – a new class of investment which includes covered warrants. The rules have two principal elements -

1. The Listing Rules. In drafting the listing rules the FSA’s intention was to create a regime which achieved a balance between investor protection and facilitating access to listed markets whilst maintaining the integrity and competitiveness of the UK market for listed securities. One such section covers the restrictions on what underlying assets which are acceptable. There are no restrictions on the style of the warrants themselves, as long as there is full disclosure in the documentation.
2. The Conduct of Business Rules. These apply obligations to authorised firms selling securitised derivatives to private customers.

The new rules officially came into force on 1st August 2002, although the launch date for covered warrants was a little later, 28th October 2002.

Issuers

Covered warrants in the UK can only be issued by financial institutions of the highest standing. The FSA has defined an absolute eligibility benchmark for all issuers that they believe will ensure the integrity of the market.

Do not expect to recognise all the names though: these are not necessarily household names, at least not in Britain. Issuing firms which have been active and highly successful in other European markets have adapted their models and procedures to match the new UK regulations.

Method of Issue

Covered warrants will generally be issued in a simple way. The listing particulars will be published, the issuer will announce the issue, and then the warrants will start trading on the London Stock Exchange. There will be no requirement to place any of the warrants before trading begins. Investors wishing to buy will therefore do so in the secondary market.

Time and Trading

Warrants traded on the London Stock Exchange order book system will be open for trading between 08h15 and 16h30, the same hours as for shares (those traded through the RSP Gateway must be for at least this time, but trading can also take place outside these hours).

Market-makers, or committed principals as they are known by the LSE, will be obliged to provide two-way prices throughout the trading day and for the lifetime of the covered warrant. These will probably, but not necessarily, be the issuers.

Constant reference to the length of life of individual warrant issues should not detract from the point that you can buy and sell warrants at any time. There is no minimum requirement for warrants to be held for any particular length of time – and certainly not until expiry. If you wish to, you can buy a warrant and sell it again five minutes later.

Quoting prices
Investors used to dealing in shares with execution-only brokers over the internet will have to sharpen their reactions to deal in covered warrants. Whereas a request for a quote for a share price will be held for thirty seconds for you to confirm the deal or back out if the price is not as good as you had hoped, quotes for covered warrants will be held for only fifteen seconds. The leverage provided by warrant prices, and their propensity to move further more quickly, means that the issuers would be exposing themselves to too much risk if quotes had a thirty-second hold requirement.

1. Introduction 2. What are covered warrants? 3. Comparison between corporate warrants and covered warrants 4. Advantages of warrants 5. Advantages of warrants – the magic of gearing 6. Disadvantages of warrants 7. Advantages & disadvantages - a summary 8. International warrants markets 9. UK warrant market 10. Types of covered warrant I (warrant terms) 11. Types of covered warrant II (underlying assets) 12. Types of covered warrant III (exotics) 13. Information on warrant terms 14. Warrant trading 15. Warrant pricing 16. Basic analysis I (underlying asset) 17. Basic analysis II (prices and terms) 18. Basic analysis III (gearing) 19. Basic analysis IV (intrinsic value) 20. Basic analysis V (premium) 21. Advanced analysis I (Black-Scholes Model) 22. Advanced analysis II (volatility) 23. Advanced analysis III (the greeks) 24. Risk 25. Trading strategies 26. Tax 27. Conclusion

• Andrew McHattie on Covered Warrants