SFC Consulation: A Healthy Market for Informed Investors - A Report on the Derivative Warrants Market in Hong Kong
Release Date: 2006-01-24
Date: January 24, 2006
Securities and Futures Commission
Chairman Mr. Martin Wheatley
Dear Chairman Martin Wheatley,
The rapid development of derivative warrants has garnered the attention of the government and society. On August 4, 2005, Our Union sent a letter to you raising two concerns, one of which was the need to re-evaluate the issuance terms of covered warrants and strengthen the regulatory framework for issuers. In November, the Securities and Futures Commission published the “A Healthy Market for Informed Investors - A Report on the Derivative Warrants Market in Hong Kong” (“The Report”) and conducted a public consultation. Our Union welcomes the concern shown by the government and the Commission regarding the warrants market. As an industry organization and a professional body, Our Union represents the interests of maintaining the financial center status of Hong Kong and China and protecting investors' interests. It is our responsibility and obligation to express our views on the current warrant market and to hope for further improvement in market quality and risk control.
Enclosed with this letter are our comments on the Report and a compilation of media reports on warrants collected by Our Union (spanning over a year from the first report on January 13, 2005). This compilation consists of 166 reports from nearly 20 different media outlets, totaling 200 pages in three volumes, submitted to the Commission for reference. These clippings gather a wide range of public opinions, including articles and announcements published by Our Union, newspaper editorials, magazine interviews, electronic media information, academic critiques, public opinions, and comments from professionals, civic groups, gambling counseling organizations, government financial officials, regulatory agencies, merchant banks, warrant issuers, Legislative Council members, community service center social workers, financial columnists, and securities industry organizations, among others (see attachments).
Our Union earnestly requests that you approach the review of the warrant market with a fair, impartial, and open attitude, gathering a wide range of opinions to ensure the stability of Hong Kong's financial system and the protection of investors' interests.
Wong Kwok On David
Hong Kong Securities and Futures Industry Staff Union
Date: January 24, 2006
Comments on the “A Healthy Market for Informed Investors - A Report on the Derivative Warrants Market in Hong Kong”
Our Union welcomes the government's and relevant authorities' attention to the warrants market. However, the “A Healthy Market for Informed Investors - A Report on the Derivative Warrants Market in Hong Kong” (hereafter referred to as the “Report”) published by the Securities and Futures Commission in November is seen as lacking comprehensiveness and breadth. It is reported that the Report mainly reflects the views of two major vested interest groups, namely the Hong Kong Stock Exchange and issuers, without responding to the demands and opinions of the public, investors, industry, and academics. This has led to criticism from the media and scholars that the Report is "all thunder and no rain."
The Report avoids addressing fundamental issues of the warrant market, repeatedly mentioning the complexity of derivatives and worrying about excessive regulation that might cause Hong Kong to lose its status as an international financial center or reduce trading volumes. It neglects how to protect investors' funds and ignores the losses investors face in the warrants market, failing to suggest strengthening the oversight of issuers. The Report focuses only on superficial issues without delving into the core problems of warrants. Overall, Our Union expresses disappointment that the Report only reviews and consults on six points:
1. Liquidity Providers
Our Union supports the existence of liquidity providers in principle. The Securities and Futures Commission should clearly outline the qualifications, responsibilities, and obligations of liquidity providers to the public, as well as their relationship with issuers. There should be regulation and penalties for violations to prevent the creation of false active trading to mislead and entice investors.
2. Issuance of Additional and Identical Warrants
Our Union believes that the current mechanism for additional issuance is inherently unfair and carries significant risks.
a. Theoretically, under the current mechanism, issuers can infinitely issue a certain warrant without hedging, potentially making the total market value larger than the underlying stock, posing limitless risk if the stock trends one-sidedly.
b. Market prices should be freely adjusted by the market to be fair. If prices deviate, investors will naturally release their holdings, reducing demand and lowering prices, making arguments about “cornering the market” fallacious.
c. Currently, investors cannot short warrants, creating unfair rules of the game. Establishing a fair short-selling system could prevent cornering and is fairer, eliminating the need for issuers to increase issuance.
3. Commission Rebates
Our Union agrees with the proposal to ban commission rebates, which could reduce illegal activities.
4. Promotional Guidelines
Our Union welcomes the forthcoming guidelines on promoting derivative warrants, hoping they will clearly define advertising, recommendations, tips, and analyses to prevent misleading investors. It should also review whether employed individuals have conflicts of interest in publicly promoting their company's warrants via the media.
5. Plain Language
Our Union supports the Commission's requirement for documents to use plain language, helping investors understand warrant listing documents and regulations better.
6. Investor Education
Investor education is a long-term task for both the Commission and the industry, and Our Union expresses its support and willingness to cooperate.
Beyond these six points, the Commission overlooks other crucial issues: a) the voices of society and investors, and b) oversight of issuers.
1. Voices of Society and Investors
A. Gambling counseling groups argue that the current warrant trading method aligns with the definition of gambling. Surveys show that 80% of investors lose money in warrants. How do authorities address this criticism and explain to citizens and investors? Have they investigated the real reasons for investor losses?
B. Have the government and authorities calculated the funds lost by Hong Kong investors in the warrants market? Could these losses cause other social issues, or negatively impact the long-term development of the Hong Kong stock market?
C. In some U.S. states, due to the complexity and risks of derivatives, retail investors are prohibited from participating, allowing only funds to trade. Given Hong Kong's information-rich environment and high number of retail investors, have authorities considered similar measures to ensure fair treatment of retail investors' funds?
D. Are the government and relevant institutions pursuing global leadership and profits at the expense of investor interests?
2. Oversight of Issuers
A. Most current warrant issuers are foreign merchant banks. Under the "dual regulation" system, which authority formally oversees them—the Monetary Authority or the Securities and Futures Commission? If an issuer encounters issues, which body is responsible?
B. Issuers must have a net asset value of over HK$2 billion, but this doesn't guarantee sufficient assets or liquidity. Theoretically, unlimited issuance could exceed HK$2 billion in market value, posing a bankruptcy risk. How does the Commission monitor this risk? Are there established guidelines for issuers regarding liquidity, business conduct, related company activities, financial resource statements, and contingent liabilities?
C. Do issuers hedge their positions, or do they simply bet against investors? How can the public know? Does the Commission have such information, and can it be disclosed? Is transparency adequate?
Warren Buffett has publicly stated that "derivatives are financial weapons of mass destruction, carrying huge credit risks concentrated in a few traders, with weak market regulation making them dangerous." At the end of last year, the Monetary Authority's Chief Executive Joseph Yam expressed concerns over the potential impact of warrants on the stock market, noting the unpredictability introduced by advanced derivatives. These perspectives should be considered by Hong Kong authorities when reviewing the warrant market's development.
Additionally, several Legislative Council members raised numerous inquiries during the January 5 meeting, which have not received positive responses from the relevant authorities. Our Union hopes these opinions are taken seriously and actively addressed.
Wong Kwok On David
Hong Kong Securities and Futures Industry Staff Union
(Attachment)
Date: January 24, 2006
Regarding the compilation of media reports on warrants, over a year has passed since the first report on January 13, 2005. A total of 166 reports have been compiled from nearly 20 different media outlets, resulting in 200 pages across three volumes. These include releases through newspapers, weekly magazines, electronic media, and announcements from the labor union. The range of commentators on warrants is extensive and includes government financial officials, regulatory bodies, merchant banks, warrant issuers, academics, Legislative Council members, community service center social workers, financial columnists, securities industry groups, organizations, educational institutions, and more. A detailed analysis includes:
1. Institutions/Including:
a. Newspapers: Oriental Daily News, Hong Kong Economic Journal, Hong Kong Economic Times, Ming Pao, Sing Tao Daily, Apple Daily, The Sun, Sing Pao Daily News, Metro Daily, Financial Times, Hong Kong Commercial Daily, The Standard, The Asia Wall Street Journal, South China Morning Post
b. Weeklies: Next Magazine, Eastweek, Next Weekly
c. Online Media: ET Net, Warrant88.com
2. Commentators Include:
a. Academics: Professor Shadi from Macquarie University, Dr. So Wai Man Raymond from The Chinese University of Hong Kong, Professor Lam Kin from Hong Kong Baptist University, Professor Billy Mak from Hong Kong Baptist University, Professor Alexander Fung from Hong Kong Baptist University, Professor Stephen Cheung Yan-leung from City University of Hong Kong, Researcher Zhong Changrong from City University of Hong Kong, Professor Chan Yan Chong from City University of Hong Kong, Mr LAM Sum Chee, Cho, Chi-ming, Christopher Cheung Wah-fung, Stephen Hui Chiu Chung, Roger Leung Sung Yeung, Ying Mingzhu
b. Chief Consultant of ET Net, Liang Yehao
c. Financial Columnists: LUI Chi Wah, Johnny, Kung Yiu Fai, Guan Tian, Mr. Vitality, Suzi, Jiang Zhongxing, Louie Shum Chun Ying, Ben Kwong Man Bun, Boss Zhou’s Notes, Inside Out, Financial Mainstream, Derivatives Forum, Gao Feng, Lu Wen, Louis Wong Wai Kit, True Feelings Revealed, Investment Panorama, Livelihood Shortwave
d. Caritas Addicted Gamblers Counselling Centre
e. Warrant Issuers: Goldman Sachs (Asia) Securities Limited, BOCOM Securities (Hong Kong) Limited
3. Publications of Press Releases, Survey Results, Books, and Research Reports on the Topic Include:
a. Hong Kong Stock Exchange Press Release "Hong Kong Stock Exchange Discusses Derivative Warrants and Solicits Opinions."
b. Securities and Futures Industry Staff Union Announcement "Warrant Questionnaire Survey Results."
c. "Securities Analysis Practice" by Lin Senci.
d. "Addicted to Gambling" compiled by the Caritas Addicted Gamblers Counselling Centre.
e. Research reports jointly produced by the Hong Kong branch of the International Accountants Association and Hantec International.
Please forgive any errors or omissions.
Securities and Futures Commission
Chairman Mr. Martin Wheatley
Dear Chairman Martin Wheatley,
The rapid development of derivative warrants has garnered the attention of the government and society. On August 4, 2005, Our Union sent a letter to you raising two concerns, one of which was the need to re-evaluate the issuance terms of covered warrants and strengthen the regulatory framework for issuers. In November, the Securities and Futures Commission published the “A Healthy Market for Informed Investors - A Report on the Derivative Warrants Market in Hong Kong” (“The Report”) and conducted a public consultation. Our Union welcomes the concern shown by the government and the Commission regarding the warrants market. As an industry organization and a professional body, Our Union represents the interests of maintaining the financial center status of Hong Kong and China and protecting investors' interests. It is our responsibility and obligation to express our views on the current warrant market and to hope for further improvement in market quality and risk control.
Enclosed with this letter are our comments on the Report and a compilation of media reports on warrants collected by Our Union (spanning over a year from the first report on January 13, 2005). This compilation consists of 166 reports from nearly 20 different media outlets, totaling 200 pages in three volumes, submitted to the Commission for reference. These clippings gather a wide range of public opinions, including articles and announcements published by Our Union, newspaper editorials, magazine interviews, electronic media information, academic critiques, public opinions, and comments from professionals, civic groups, gambling counseling organizations, government financial officials, regulatory agencies, merchant banks, warrant issuers, Legislative Council members, community service center social workers, financial columnists, and securities industry organizations, among others (see attachments).
Our Union earnestly requests that you approach the review of the warrant market with a fair, impartial, and open attitude, gathering a wide range of opinions to ensure the stability of Hong Kong's financial system and the protection of investors' interests.
Wong Kwok On David
Hong Kong Securities and Futures Industry Staff Union
Date: January 24, 2006
Comments on the “A Healthy Market for Informed Investors - A Report on the Derivative Warrants Market in Hong Kong”
Our Union welcomes the government's and relevant authorities' attention to the warrants market. However, the “A Healthy Market for Informed Investors - A Report on the Derivative Warrants Market in Hong Kong” (hereafter referred to as the “Report”) published by the Securities and Futures Commission in November is seen as lacking comprehensiveness and breadth. It is reported that the Report mainly reflects the views of two major vested interest groups, namely the Hong Kong Stock Exchange and issuers, without responding to the demands and opinions of the public, investors, industry, and academics. This has led to criticism from the media and scholars that the Report is "all thunder and no rain."
The Report avoids addressing fundamental issues of the warrant market, repeatedly mentioning the complexity of derivatives and worrying about excessive regulation that might cause Hong Kong to lose its status as an international financial center or reduce trading volumes. It neglects how to protect investors' funds and ignores the losses investors face in the warrants market, failing to suggest strengthening the oversight of issuers. The Report focuses only on superficial issues without delving into the core problems of warrants. Overall, Our Union expresses disappointment that the Report only reviews and consults on six points:
1. Liquidity Providers
Our Union supports the existence of liquidity providers in principle. The Securities and Futures Commission should clearly outline the qualifications, responsibilities, and obligations of liquidity providers to the public, as well as their relationship with issuers. There should be regulation and penalties for violations to prevent the creation of false active trading to mislead and entice investors.
2. Issuance of Additional and Identical Warrants
Our Union believes that the current mechanism for additional issuance is inherently unfair and carries significant risks.
a. Theoretically, under the current mechanism, issuers can infinitely issue a certain warrant without hedging, potentially making the total market value larger than the underlying stock, posing limitless risk if the stock trends one-sidedly.
b. Market prices should be freely adjusted by the market to be fair. If prices deviate, investors will naturally release their holdings, reducing demand and lowering prices, making arguments about “cornering the market” fallacious.
c. Currently, investors cannot short warrants, creating unfair rules of the game. Establishing a fair short-selling system could prevent cornering and is fairer, eliminating the need for issuers to increase issuance.
3. Commission Rebates
Our Union agrees with the proposal to ban commission rebates, which could reduce illegal activities.
4. Promotional Guidelines
Our Union welcomes the forthcoming guidelines on promoting derivative warrants, hoping they will clearly define advertising, recommendations, tips, and analyses to prevent misleading investors. It should also review whether employed individuals have conflicts of interest in publicly promoting their company's warrants via the media.
5. Plain Language
Our Union supports the Commission's requirement for documents to use plain language, helping investors understand warrant listing documents and regulations better.
6. Investor Education
Investor education is a long-term task for both the Commission and the industry, and Our Union expresses its support and willingness to cooperate.
Beyond these six points, the Commission overlooks other crucial issues: a) the voices of society and investors, and b) oversight of issuers.
1. Voices of Society and Investors
A. Gambling counseling groups argue that the current warrant trading method aligns with the definition of gambling. Surveys show that 80% of investors lose money in warrants. How do authorities address this criticism and explain to citizens and investors? Have they investigated the real reasons for investor losses?
B. Have the government and authorities calculated the funds lost by Hong Kong investors in the warrants market? Could these losses cause other social issues, or negatively impact the long-term development of the Hong Kong stock market?
C. In some U.S. states, due to the complexity and risks of derivatives, retail investors are prohibited from participating, allowing only funds to trade. Given Hong Kong's information-rich environment and high number of retail investors, have authorities considered similar measures to ensure fair treatment of retail investors' funds?
D. Are the government and relevant institutions pursuing global leadership and profits at the expense of investor interests?
2. Oversight of Issuers
A. Most current warrant issuers are foreign merchant banks. Under the "dual regulation" system, which authority formally oversees them—the Monetary Authority or the Securities and Futures Commission? If an issuer encounters issues, which body is responsible?
B. Issuers must have a net asset value of over HK$2 billion, but this doesn't guarantee sufficient assets or liquidity. Theoretically, unlimited issuance could exceed HK$2 billion in market value, posing a bankruptcy risk. How does the Commission monitor this risk? Are there established guidelines for issuers regarding liquidity, business conduct, related company activities, financial resource statements, and contingent liabilities?
C. Do issuers hedge their positions, or do they simply bet against investors? How can the public know? Does the Commission have such information, and can it be disclosed? Is transparency adequate?
Warren Buffett has publicly stated that "derivatives are financial weapons of mass destruction, carrying huge credit risks concentrated in a few traders, with weak market regulation making them dangerous." At the end of last year, the Monetary Authority's Chief Executive Joseph Yam expressed concerns over the potential impact of warrants on the stock market, noting the unpredictability introduced by advanced derivatives. These perspectives should be considered by Hong Kong authorities when reviewing the warrant market's development.
Additionally, several Legislative Council members raised numerous inquiries during the January 5 meeting, which have not received positive responses from the relevant authorities. Our Union hopes these opinions are taken seriously and actively addressed.
Wong Kwok On David
Hong Kong Securities and Futures Industry Staff Union
(Attachment)
Date: January 24, 2006
Regarding the compilation of media reports on warrants, over a year has passed since the first report on January 13, 2005. A total of 166 reports have been compiled from nearly 20 different media outlets, resulting in 200 pages across three volumes. These include releases through newspapers, weekly magazines, electronic media, and announcements from the labor union. The range of commentators on warrants is extensive and includes government financial officials, regulatory bodies, merchant banks, warrant issuers, academics, Legislative Council members, community service center social workers, financial columnists, securities industry groups, organizations, educational institutions, and more. A detailed analysis includes:
1. Institutions/Including:
a. Newspapers: Oriental Daily News, Hong Kong Economic Journal, Hong Kong Economic Times, Ming Pao, Sing Tao Daily, Apple Daily, The Sun, Sing Pao Daily News, Metro Daily, Financial Times, Hong Kong Commercial Daily, The Standard, The Asia Wall Street Journal, South China Morning Post
b. Weeklies: Next Magazine, Eastweek, Next Weekly
c. Online Media: ET Net, Warrant88.com
2. Commentators Include:
a. Academics: Professor Shadi from Macquarie University, Dr. So Wai Man Raymond from The Chinese University of Hong Kong, Professor Lam Kin from Hong Kong Baptist University, Professor Billy Mak from Hong Kong Baptist University, Professor Alexander Fung from Hong Kong Baptist University, Professor Stephen Cheung Yan-leung from City University of Hong Kong, Researcher Zhong Changrong from City University of Hong Kong, Professor Chan Yan Chong from City University of Hong Kong, Mr LAM Sum Chee, Cho, Chi-ming, Christopher Cheung Wah-fung, Stephen Hui Chiu Chung, Roger Leung Sung Yeung, Ying Mingzhu
b. Chief Consultant of ET Net, Liang Yehao
c. Financial Columnists: LUI Chi Wah, Johnny, Kung Yiu Fai, Guan Tian, Mr. Vitality, Suzi, Jiang Zhongxing, Louie Shum Chun Ying, Ben Kwong Man Bun, Boss Zhou’s Notes, Inside Out, Financial Mainstream, Derivatives Forum, Gao Feng, Lu Wen, Louis Wong Wai Kit, True Feelings Revealed, Investment Panorama, Livelihood Shortwave
d. Caritas Addicted Gamblers Counselling Centre
e. Warrant Issuers: Goldman Sachs (Asia) Securities Limited, BOCOM Securities (Hong Kong) Limited
3. Publications of Press Releases, Survey Results, Books, and Research Reports on the Topic Include:
a. Hong Kong Stock Exchange Press Release "Hong Kong Stock Exchange Discusses Derivative Warrants and Solicits Opinions."
b. Securities and Futures Industry Staff Union Announcement "Warrant Questionnaire Survey Results."
c. "Securities Analysis Practice" by Lin Senci.
d. "Addicted to Gambling" compiled by the Caritas Addicted Gamblers Counselling Centre.
e. Research reports jointly produced by the Hong Kong branch of the International Accountants Association and Hantec International.
Please forgive any errors or omissions.