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Q&A

What are Renminbi warrants?
In Hong Kong, derivative warrants denominated, traded, and settled in Renminbi, with underlying assets also denominated in Renminbi, are commonly known as “Renminbi warrants”.

History of Renminbi-denominated securities began in 2011, as Hui Xian REIT (87001.HK), the first Renminbi-denominated securities in Hong Kong, was listed. After the launch of the Renminbi Qualified Foreign Institutional Investor (“RQFII”) scheme, several physical, dual-counter A-share Exchange Traded Funds (“ETF”) were also listed subsequently. These dual-counter ETFs offers two counters, namely, a Renminbi (RMB) counter and a Hong Kong dollar (HKD) counter. The two counters are of the same class but with a different stock code.

As these physical A-share ETFs emerge and become increasingly popular, demand for the respective derivative products also arises. The Hong Kong Exchanges (HKEX) approved Renminbi warrants, which are derivative warrants denominated, traded and settled in Renminbi, in the fourth quarter of 2012.The first batch of approved underlying assets includes three Renminbi denominated securities, namely:

1. Hui Xian REIT (87001.HK)
2. RMB counter of ChinaAMC CSI 300 Index ETF (83188.HK)
3. RMB counter of CSOP FTSE China A50 Index ETF (82822.HK)

Following extensive discussion with HKEX, BNP Paribas successfully obtained approval from the Exchange, launching the first Renminbi warrant ever in Hong Kong. As the first Renminbi warrant issuer, BNP Paribas has made a key first step into the Hong Kong exchange-listed Renminbi derivatives market!

While institutional investors may go through the over-the counter (“OTC”) market when they need a leveraged Renminbi-denominated product, it is not the case for retail investors. The launch of Renminbi warrants complements this gap by offering leveraged Renminbi-denominated derivatives to all types of investors, whether they are institutional or retail, through the HKEX platform – investors are now able to gain leveraged exposure to their Renminbi funds through Renminbi warrants. Having said that, Renminbi warrants have at least as many risks as an ordinary HKD-denominated warrant would have, therefore, investors must be aware of these risks when dealing with Renminbi warrants.
Characteristics of Renminbi warrants
There are five major characteristics of Renminbi warrants:

Leveraged
As the liquidity of Renminbi improves over the years, demand for Renminbi-denominated products also increased over time. As a leveraged product, Renminbi warrants generates gains or losses for the investors which can be multiples of those of the underlying asset.

Low Investment Outlay Required
Despite the increasing demand for Renminbi-denominated investment products, leveraged Renminbi products were limited to OTC products such as swaps before Renminbi warrants were introduced to the market by BNP Paribas. These OTC products are only offered to professional investors and substantial initial investment is usually required.

Denominated, Traded and Settled in Renminbi
Renminbi warrants are denominated, traded and settled in Renminbi – this means that investors can buy Renminbi warrants by paying Renminbi, and if investors hold the Renminbi warrants until maturity, any cash settlement values will be payable in Renminbi as well.

Easy to Execute
Same as HKD-denominated warrants, Renminbi warrants can be traded using ordinary Hong Kong stock accounts, as long as the executing broker can deal in and clear transactions in Renminbi. (Depending on individual brokers’ requirements, investors may need to open and maintain an Renminbi account with the broker first before dealing in Renminbi warrants. ) Trading procedures and associated risks are similar as well except Renminbi warrants are denominated, traded and settled in Renminbi.

Listed on HK Exchange
Listed on the Hong Kong exchange, Renminbi warrants offer high transparency to investors. Renminbi warrants have dedicated liquidity providers, are stamp-duty free and cash settled, just like ordinary derivative warrants.
Factors that affect the price of Renminbi warrants
The five major factors that would affect the price of Renminbi warrants are the same as those that would affect the price of ordinary HKD-denominated warrants, which are, namely:
1. Price of the Underlying Asset
2. Time to Maturity
3. Implied Volatility
4. Interest Rate
5. Dividend

Price of the Underlying Asset
Call warrants grant investors the right to get a cash settlement amount equivalent to buying the underlying asset at the strike price at maturity; whereas put warrants grant investors the right to get a cash settlement amount equivalent to selling the underlying asset at the strike price at maturity. Thus, before the maturity date, given all other factors unchanged, a higher spot price of the underlying means that the call warrant is worth more and the put warrant is worth less.

In analyzing the price of warrants, one can divide it into two parts, intrinsic value and time value. Intrinsic value is defined as the difference between the underlying spot and the strike of the warrant. Intrinsic is spot minus strike for calls and strike minus spot for puts. The intrinsic value of in-the-money calls increases with spot and the intrinsic value of in-the-money puts decreases with spot. At-the-money and out-of-the-money warrants have zero intrinsic values.

Time to Maturity
Other than intrinsic value, the remaining value of a warrant is referred to as time value, which is, amongst other factors, a function of the time to maturity of the warrant. As time passes by, given all other factors unchanged, warrants, no matter call or put, become generally cheaper. We call this decline in the value of the warrant over time “time value decay”, or simply “time decay”.

Since warrants have limited downside but unlimited upside, there is higher chance for underlying spot to turn favorable for products with longer tenor, hence, time to maturity normally has a positive impact to the price of warrants. We generally observe that longer-dated warrants are usually more expensive than shorter-dated warrants, given all other factors identical.

It is worth noting that time value normally decays exponentially, mean that time decay becomes faster and faster as the warrant approaches its maturity date.

Implied Volatility
Implied volatility level of the underlying is another factor that has an impact on the time value of a warrant, and hence the overall value of the warrant. Again, since warrants have limited downside but unlimited upside, a higher level of implied volatility of the underlying asset means that there is higher chance for the price of the underlying asset to turn favorable at maturity, which is positive for the price of the warrant, no matter call or put. Warrant issuers often source hedge from the OTC options market, thus the implied volatility levels of OTC options are often used as the reference when pricing warrants.

Interest Rate
When interest rate increases, so does the opportunity cost of money. Since more upfront is required when buying stocks than when buying warrants for the same notional, investors have greater incentives to buy warrants when interest rate is higher. Thus, price of call warrants increases with interest rate. On the other hand, since opportunity cost of money is higher when interest rate is higher, investors have more incentives selling stocks than buying puts, thus, a higher interest rate should have a negative impact on the price of a put warrant. For Renminbi warrants, the interest rate of Renminbi is the interest rate that affects the price of the warrants.

Dividend
Warrant issuers have already considered the effect of dividends when they sell to investors. As a result, if the actual dividend is identical to the expected dividend, the dividend itself should have no impact to the price of the warrant. However, when the actual dividend is greater than what the issuer expected, it tends to be negative for a call and positive for a put; if the actual dividend is lower than the expected dividend or if the dividend is omitted altogether, it should be positive for a call and negative for a put.

Another scenario that one needs to pay attention to is that of special dividends. If there is a cash distribution, whether in the form of special dividend, extraordinary dividend, or cash bonus, which exceeds more than 2% of the spot price as of the date of the announcement, warrant issuers will adjust the terms of the warrant accordingly such that the price of the warrant should remain theoretically the same right after the special dividend is paid. Otherwise, if the cash distribution is less than 2% of the spot price as of the announcement date, it will be negative for a call and positive for a put since the actual dividend is greater than the expected dividend.

How are Renminbi warrants settled?
Renminbi warrants are cash-settled, just like all other warrants currently found in Hong Kong. When warrants expire, issuers will automatically calculate and pay (if any) the cash settlement amount to the investors’ securities account via CCASS. Investors have to note that, however, there may be exercise expenses, brokerage commission or other trading fees subject to the investors’ mutual agreement with their brokers or banks.

For Renminbi warrants, they are cash-settled in Renminbi, i.e. cash settlement amount (if any) will be paid to the investors in Renminbi.

The cash settlement amount for a Renminbi warrant is calculated in exactly the same way as that of an otherwise identical HKD-denominated warrant, as follows:
Cash settlement amount per unit of Renminbi call =
(Average closing of the underlying on the five trading days preceding the expiry date – Strike) / Divisor

Cash settlement amount per unit of Renminbi put =
(Strike – Average closing of the underlying on the five trading days preceding the expiry date) / Divisor

It is worth noting that half trading days (e.g. Christmas Eve, New Year Eve, Chinese New Year Eve) are valid trading days for the purpose of calculation of the five-day average closing price. For details of arrangements for other special cases such as when trading is halted due to typhoons or Black Rain, please refer to the listing documents of the Issuer.
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