China is to launch warrant certificates on the domestic stock market, which experts say offers a new financial tool for investors and an alternative for listed firms to float their non-tradable shares.

A warrant gives the holder the right - but not the obligation - to buy or sell a certain number of securities from the issuer at a specific price within a certain time frame.

Yesterday Shanghai and Shenzhen stock exchanges published circulars about the warrants, which have already got approval from market watchdog, the China Securities Regulatory Commission.

According to the circulars, listed firms issuing warrants should have at least 300 million negotiable stocks, whose market value should be no less than 3 billion yuan (US$363 million) in the 20 trading days leading up to the issuance. At least 25 per cent of the firm's shares must change hands in the 60 trading days before issuance.

A listed firm must issue at least 50 million warrants and there should be at least 100 investors holding more than 1000 warrants. The expiry period should be over 6 months and less than 24 months.

About a month ago, the two stock exchanges revealed their draft circulars to find out public opinion. The official circulars issued yesterday have stricter requirements in terms of whether the issuer qualifies, which leaves less than 30 potential issuers.

Experts say warrants are widely used in developed markets and China has been seeking the right time to introduce the practice into the domestic market.

Warrants are a useful financial tool offering significant gains to an investor during a bull market. They can also offer protection to investors during a bear market.

This is because as the price of a share begins to drop, the warrant still empowers the holder to sell the shares to the warrant issuers at a specified price higher than the market price. On the other hand, a call warrant - the right to buy shares lets its holder buy the securities at a lower price and quantity when share prices have risen.

The warrant certificate will also offer a new approach to listed firms to reform their share structure, said Hua Sheng, an economist who initiated the idea of using warrants to push market reform.

Besides paying cash and shares to those selling tradable shares, warrants can also be used to compensate those people.

But the method has not been widely understood by investors, said Dong Chen, a senior analyst at China Securities.

Until now, of 46 pilot firms, only one company - the Baosteel Iron & Steel Corp - proposed this method and it has yet to be passed at the general shareholders' meeting.

There should be adequate education to let investors understand the new tool and learn how to use it, he said.

"Warrants are a two-edged weapon", said Liu Haobo, an analyst at CITIC Securities.

Like any other type of investment, they also have their drawbacks and risks, he said.

For example, when the outcome is contrary to expectations, investors will suffer not only share price fluctuations but also the cost of buying the warrants.

Moreover, how to price the warrant certificate is a big problem, Liu said.

The warrants pricing system is based on the option pricing system, but there is no such financial product nor pricing system in the domestic market, he said.

Warrants were launched when China established its stock market in 1992, but they were abolished in 1996 due to the abuse of speculators. At that time, warrant prices were even higher than underlying share prices.

The circulars issued yesterday also specified the two stock exchanges would closely monitor the trading of warrants and prices will only be able to fluctuate within a fixed range.

(China Daily 07/19/2005 page9)