Cover Up! Hong Kong's Regulation of Exchange-Traded Warrants

Abstract

Regulatory interest in financial derivatives centres on how unforeseen shocks might affect their value. Current concerns arise from prolific growth in the use of derivatives by financial institutions for credit risk transfer, the scale of which some national authorities find disquieting. However, attention in Hong Kong applies to a wholly different setting, springing from its prominent market in listed covered warrants. The regulatory regime for these instruments is fractured, porous, and conflicts with precepts of international practice to which the territory nonetheless subscribes. Primary oversight is entrusted to the Stock Exchange of Hong Kong, a body neither equipped nor inclined to perform the function authoritatively. Slender, variable disclosure requirements do little to inform participants as to the balance of risk and reward inherent in these products, and since most warrant buyers are non-professional individuals, a pronounced market correction would create a significant moral hazard for Hong Kong's government.