Market is predicted to grow by some 380% if the LSE begins trading in covered warrants
The UK warrants market will increase by 380% if the London Stock Exchange (LSE) introduces its anticipated market in covered warrants at the end of April, according to Andrew McHattie, publisher of Warrants Alert, the newsletter from the McHattie Group.
Investment Week revealed at the end of November last year that the FSA was planning to widen the derivatives market to allow retail investors to invest in the sector directly via the LSE.
McHattie said the new regulations will mean between a five and 10-fold multiplication in the number of warrants available to private investors on the LSE. This means the 120 warrants currently in issue will increase to 500 when the market opens.
The FSA is to publish the definitive listing rules in April and McHattie said the new market will open after that.
Covered warrants are proprietary instruments issued by financial institutions that give the holder the right to buy or sell an asset at a specified strike price during, or at the end of, a specified period.
The warrants are expected to be available on a broad range of blue chip companies, sector baskets and both UK and overseas indices. Holders can buy calls and puts, enabling them to use the warrants as a way of hedging bets.
The covered warrants can be used as a vehicle for tracking the index. The lack of stamp duty makes them attractive relative to tracker funds.
However, unlike tracker funds, investors have to pay a premium for the warrant in exchange for the gearing element. McHattie said that it is difficult to know at this point if they will be cheaper than tracker funds.
In the UK market, warrants are currently only issued by investment trusts or companies. Due to their illiquidity and volatility in this area, many investment trusts no longer deal in them. Some 23 warrants are due to expire this year.
Yet in places like Germany there is a large covered warrants market, with some 30,000 available.
McHattie said that on a busy day, there can be 200 new warrants issued.
He added: 'The UK is unlikely to reach this kind of level for some time. Indeed, the need to avoid placing the new system under too much stress will probably mean some limits are initially placed on the issuers so the market starts off at a relatively gentle pace.
'That said, from the beginning, we still expect the number of covered warrant issues to exceed the number of company and investment trust warrants currently issued. By the end of 2002, we expect there to be around 1,000 warrants in the UK market.
'The attractiveness for retail investors of these warrants is that they will be free of stamp duty, they will be very liquid and easy to trade and they will be listed on the LSE.'
However, McHattie said it is unlikely the covered warrants will be Isable as, at present, individual warrants cannot be put in an Isa, although warrant funds can.
It is uncertain if covered warrants within a fund will be treated the same way.
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From 6 April 2019