CHINA WARRANTS MARKET IS BIGGEST

Less than 18 months after the first warrant was issued on China's stock exchanges, the country now boasts the world's biggest market for the financial instrument.

Chinese investors' love affair with warrants was an accidental outcome arising from a set of last-gasp stock market reforms and has been stoked up by a speculative fever that may not last.

Like options, warrants allow investors to buy a security at a future date for a fixed price. Warrants can also be bought and sold in their own right, making them potential objects of speculation as well.

According to data compiled by Goldman Sachs, warrant turnover on the Shanghai and Shenzhen stock exchanges reached $221.2bn over the first 11 months of 2006, against $207.8bn in Hong Kong.

Hong Kong's full-year turnover came in at $230bn, with incomplete statistics for China suggesting its final figure would exceed $244bn.

This is in spite of only 27 warrants being traded in China compared with more than 2,000 in Hong Kong.

Zhu Huacheng, derivative products analyst with Xiangcai Securities, said China warrants could change hands up to 150 times before exercise, compared with just 10 times in more mature markets. Warrants were embraced in China to help listed state-owned enterprises out of an awkward bind. Listed state companies had two classes of shares, one that could be traded on stock exchanges and the other that could not.

To realise the value of their non-tradeable "state shares", state-owned enterprises needed to render them tradeable. This required approval from minority shareholders, who feared dilution from the release of a large overhang of state shares.

To win their minorities over, state companies gifted investors free bonus shares and, in some cases, free warrants as well. In Hong Kong and other markets, investors buy warrants issued by independent third parties, such as investment banks.

Cheril Lee, executive director and head of Goldman's securitised derivative products in Hong Kong, said the market's momentum would depend on further initiatives from China's regulator, which has not yet given blanket approval for third-party issues but approves them on a one-off basis.

"It seems like they are quite supportive of warrants," Ms Lee said. "If the regulator allows third party warrants the market can stay [at current levels]."