Morgan Stanley and Citigroup are among firms preparing a move into Hong Kong’s $15 billion-a-day derivative warrants market, according to four industry sources. The Hong Kong arm of Chinese securities house Guotai Junan International is also set to enter the fray.
“Morgan Stanley are pretty much ready [to issue], but the market is not looking very promising at the moment,” says an executive with direct knowledge of the matter, who works at a bank issuing Hong Kong-listed warrants. A warrants sales executive at a European bank echoes that, saying Morgan Stanley and Citi may be waiting for market conditions to improve, and adds: “I’ve heard that Guotai are targeting to issue their product by the end of this year.”
The plans mark a reversal of a recent trend. As greater competition has squeezed margins on the products and Basel III has raised their regulatory costs, the number of active issuers of Hong Kong warrants has declined, falling from more than 20 in 2007 to 12 currently. For Citi, it would be a return to a market the bank left a few years ago.
Dealers say a boom in Hong Kong-listed stocks – the Hang Seng Index has rallied by roughly 34% since January 2017 – has probably sparked the renewed interest.
However, it is unlikely to be plain sailing for the new entrants.
“Normally we see banks looking to set up in this business after a bull run because they see other houses making money,” says a fifth source – Ivan Ho, who heads Hong Kong warrants sales at Credit Suisse. “But the market situation is not as good as it was two years ago. A favourable market would be one where the economy is foreseeable but the US and China are still negotiating a trade deal.”
China’s economy cooled at the end of last year, with GDP growth falling from 6.5% in the third quarter to 6.4% in the fourth – the slowest rate of growth since the global financial crisis.
Playing the long game
Other hurdles to success in the world’s most actively traded warrants market are more technical.
Dealers say new issuers should invest heavily in trading platforms, including spending on low-latency co-location with the Hong Kong exchange, to protect themselves from arbitrage by high-frequency trading firms.
“You’ve got to play the long game on that because it might take you two or three years until you get pay back on it,” says a regional head of equity products at another bank. “To build it all it takes a year, and then you’ve got to get your name out there, so you have to spend more time pushing it.”
The instruments, which, similar to options contracts, give investors the right but not the obligation to buy an underlying stock at a certain price, can also be tricky to risk-manage. Dealers say it has become especially difficult to source volatility to hedge warrants positions, due to slower activity in structured products and illiquidity in over-the-counter options in Hong Kong.
For now, the three firms are pressing on in hopes of capturing a slice of the fast-growing market. Daily turnover in Hong Kong warrants averaged $15 billion in 2018, a 28% increase on 2017, according to data published by exchange operator HKEX and Hong Kong’s Securities and Futures Commission.
The trio have been busy hiring warrants traders in recent months. According to his LinkedIn profile, Albert Chan joined Morgan Stanley from Societe Generale in December to head up the bank’s nascent warrants trading unit. In March, meanwhile, Citi advertised for a new head of its listed structured products business, describing the role as “a position to lead and develop our HK warrants business”.
Morgan Stanley and Guotai Junan did not respond to requests for comment. A Citi spokesperson says the bank is unable to discuss the matter at present.
Editing by Olesya Dmitracova