Published February 13, 2009

Seeking a reprieve from 'death warrants'

By R SIVANITHY
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WHEN the structured warrant segment first sparked to life some four years ago, there were high hopes that it might one day rival Hong Kong's in terms of sophistication, depth and breadth. And, to be sure, the signs were encouraging - volume rose from a modest $1.5 billion in 2004 to a record $28 billion in 2007 as issuers raced to set up shop here and offer traders more instruments to capitalise on the bull market.

Industry observers would know that due to the global banking crisis, that trend has now reversed sharply.

No thanks to the resulting debilitating bear market, prominent issuers such as Deutsche Bank (which pioneered warrants trading in Singapore with its 'supermarket' approach), SG Securities (which, together with Deutsche and Macquarie Securities, dominated market share for years) and Merrill Lynch have shut down their Singapore operations over the past month and are now running their Singapore warrants business out of Hong Kong.

There can be no faulting the decision to do this; as with all aspects of broking/investing, the warrants business is a numbers game and for the past several months, the numbers simply didn't add up. Daily volume in warrants now averages only $30-50 million - down some 70-80 per cent from the heady days of 2007's $150-200 million and early 2008. This makes some prevailing arrangements commercially unviable.

Reasons for hope

The big question, of course, is: Does this signify the end of the warrants market in Singapore? Furthermore, with the recent introduction of a new derivative instrument called the Extended Settlement (ES) contracts by the Singapore Exchange (SGX), will this mean a drying up of already-thin liquidity in the warrants segment?

Although the signs are currently not positive and the warrants market is well and truly mired in the doldrums, there are plenty of reasons to hope that as long as the underlying market recovers fairly quickly, all is not lost.

First and most important, thanks to the educational efforts of issuers and SGX over the past few years, the level of sophistication within the ranks of warrant traders here can justifiably be said to be almost on par with Hong Kong's.

Anecdotal evidence from issuers is that queries from the public these days are no longer about the basics of warrant trading but, instead, about much more advanced concepts relating to hedging, bid-ask spreads and implied volatility. Traders are also known to attend specialised training courses to gain the necessary expertise and to thereafter focus entirely on trading warrants.

Widespread understanding

Since warrant knowledge and understanding is now widespread, it would be safe to assume that there will be no need to undergo the gradual learning curve that was necessary between 2002 and 2004, and interest should return rapidly once the underlying market recovers.

Second, although ES contracts are derivatives like warrants, they are more like futures contracts and possess different characteristics to warrants - deposits and margins have to be paid, the settlement counterparty is SGX, and the life span is only 30 days. It's very possible that instead of competing for the warrants dollar, ES contracts will complement the warrants segment since it affords hedging and arbitrage opportunities. As one trader said, 'you can leave it to the market to find ways to make money'.

The key, of course, lies with the underlying market; no one knows how long it will take for governments and central banks to fix the mess left in the wake of the US sub-prime mortgage crisis and, to be honest, it isn't entirely obvious to us that printing money and throwing it at the problem is the best approach.

Hopefully, though, the recovery won't take too long, and once the turn comes, there's every reason to be optimistic that the warrants segment will make a comeback as well.