Geared for risk

Hong Kong is the world's biggest warrants market. Average daily turnover in the city for warrants (and its close kin, the callable bull/bear contract) clocks in at a thumping HK$19.3 billion, according to figures from HSBC.

As to why the product is so popular, Shirley Kwok, head of exchange-traded solutions sales for Hong Kong and Singapore at BNP Paribas, says simply: 'Hong Kong people like to gamble.'

The warrants market does have casino-like features. Warrants contain an option to buy or sell a security - typically, equities. If a share goes up or down enough in value such that the option can be exercised, an investor can recoup several times the amount of their investment. If not, it expires worthless. The leveraging effect of warrants, their ease of use and the all-or-nothing aspect of returns is reminiscent of gambling, where punters risk losing their entire stake for the chance to win big.

There are 22 warrant issuers in Hong Kong who listed 7,826 warrants last year - a record rate of issuance and an 85 per cent increase year on year, according to Hong Kong Exchanges and Clearing (HKEx). But recently, developments involving two issuers - Deutsche Bank and Goldman Sachs - have highlighted some of the risks in this highly geared derivatives market.

Last month, several people were arrested - including two Deutsche Bank executives - as part of an investigation by the Independent Commission Against Corruption. The two bank staff are suspected of conspiring to accept bribes from a stock investor and others for quoting favourable prices to them, enabling them to make profits. Those arrested are suspected of conspiring to defraud the bank and the investing public by creating a false or misleading appearance of active trading in derivative warrants.

That followed a trading halt of four warrants issued by Goldman that were linked to the Nikkei 225 Index. There was a typographical error in the original listing documents. The error was in the formula used to calculate the cash settlement amount once the warrants matured. The warrants had not matured by the time the error was detected and corrected. Goldman announced a plan three weeks after trading was halted to buy back the warrants at a premium, ensuring investors would not lose money, according to the bank. The return investors received from the buy-back offer, however, varies depending on the amount they paid for the warrants.