Domestic fund management companies are allowed to invest in warrants, according to a circular released yesterday by market watchdog China Securities Regulatory Commission (CSRC).

The new rule broadened the business scope of mainland funds because fund managers are only allowed to invest in securities and bonds, said Hua Sheng, the economist who initiated the idea of using warrants as a tool to push the state share flotation reform.

A warrant, like an option, gives the holder the right but not the obligation to buy an underlying security at a certain price, quantity and future time. However, unlike an option, an instrument of the stock exchange, a warrant is issued by a company.

The security represented in the warrant is delivered by the issuing company instead of an investor holding the shares.

Besides offering share and cash compensations to the tradable shareholders, some companies also issue warrants to protect the interest of the small shareholders when floating the non-tradable shares.

For instance, the power heavyweight China Yangtze Power issued 1.5 warrants to the tradable shareholders for each 10 shares held. The warrants entitle the holders to purchase the company's shares at 5.5 yuan (68 US cents) per share when the share price increased higher.

The warrant holders can also choose to sell their warrants at the price of 1.8 yuan (22 US cents) a piece to the issuer.

Steel heavyweight Baosteel also issued warrants to its tradable shareholders.

Most funds are big tradable shareholders of the companies issuing warrants.

CSRC's circular said the fund managers are allowed to not only hold, sell or exercise their warrants, but also buy warrants sold on the market.

Actually, warrants had been launched in the domestic stock market in the early 1990s when China established the stock market.

But it was abolished later because of rampant speculation, according to Dong Chen, a senior analyst at China Securities.

The warrant prices were even higher than the underlying securities before the suspension by the regulator, he said.

To avoid the speculation again, CSRC yesterday made many specific restrictions on the investment of warrants by fund management companies.

The money from a fund invested in warrants in a certain trading day could be at most 5 percent of the fund's net asset of the one from an earlier trading day.

The market value of the total warrants held by a fund could be at most 3 percent of the fund's total asset at any time.

Moreover, a fund could hold at most 10 percent of a certain company issuing the certain warrants.

In fact, only a few listed companies choose to issue warrants to their tradable shareholders and the warrants volume will not be very large, said Hua Sheng.

(China Daily August 18, 2005)