Turkey: Warrants Have Finally Made It To The Turkish Capital Market

A warrant, in its general sense, is a security that entitles the holder to purchase or sell a specific number of shares from a company at a particular price, the so-called exercise price, within a certain term according to the terms of the issue. Warrants are often attached to bonds or stocks as "sweeteners," issued by companies when they make a new issue of shares, in order to attract potential buyers. As they comprise only a fraction of the price of the share itself, investors may potentially benefit from the growth of a much larger shareholding.

Advantages and Handicaps

Warrants provide investment alternatives to investors and increase market depth and width and the capital market's contribution to the country's economy. As with every capital market instrument, warrants also have advantages and disadvantages.

Advantages of warrants are as follows:

1. Opportunities to Gain Both in Rising and Falling Markets: Warrants provide the right to purchase the related capital market instrument and present opportunities for gain in rising and falling markets.

2. Prevention of Risk: Warrants are of the same nature as options and have the purpose of reducing risks which may arise from economic instability. However, there are some differences between warrants and options:

a. A warrant is a type of security; an option is an agreement.

b. Warrants are traded on the stock market; options are traded on derivatives exchanges.

c. Warrants are issued by financial institutions; options are issued by the Derivatives Exchange.

d. Warrants are not standardized products. An issuer may issue warrants having various features, sizes, terms or prices. Options are standardized products of the Derivatives Exchange.

e. Warrants are long-term instruments; options are short-term instruments. (Usually valid for a maximum period of nine months)

f. Warrants have no minimum transaction limit; options have a minimum transaction limit.

g. Partnership warrants are generally delivered in dematerialized form; options have to be delivered physically.

h. Unlike warrants, a seller of options deposits security at a certain percentage of the option's value.

3. Unlimited Gain, Limited Loss: The amount of loss that may arise is limited to the price paid for the warrant.

On the other hand, warrants pose the following risks:

1. Leverage Effect: The rate of the loss is always limited to the purchase price of the warrant. However, sometimes, a small change in the price of an underlying asset can lead to a substantial decline in the value of warrants.

2. Risk of Loss Despite Selection of an Appropriate Capital Market Instrument: The price changes of the related capital market instrument influence the price of the warrant. However, this is not the only variable determining a warrant's price. There may be other factors which trigger loss. (e.g. daily emerging developments)

3. Default Risk of the Issuer: Warrants have significant similarities to options. Although the fulfillment of seller's obligation is assured by the clearing institution for options, there is no such guarantee for warrants. If the issuer does not fulfill its obligation at the end of the term, the warrant owner may start legal proceedings as an ordinary creditor.

4. Limited Validity Period: Partnership warrants are different from shares, because they are valid for a limited period. The life of the partnership warrant ends up with the end of its term.

Although warrants have been in existence in various countries for many decades, the Capital Market Board (the "CMB") of Turkey has recently introduced this investment tool to Turkish capital markets through the issuance of a new Communiqué (Serial: III, No: 36) (the "Communiqué"). The Communiqué sets forth the equity call warrants ("Partnership Warrants") that more resemble "call options," giving the investor the option to buy the issuer shares of the company itself or the common shares of other listed companies trading on the Istanbul Stock Exchange (the "ISE"). If the listed company is issuing Partnership Warrants on its own shares, then it must adopt registered capital system until the exercise date of the Partnership Warrant.

In order to issue a Partnership Warrant, both the Partnership Warrant and the capital market instrument to which the Partnership Warrant is attached must be registered with the CMB. However, the issuer is not obliged to prepare a separate registration statement and prospectus. The information relating to a Partnership Warrant (e.g., rights, maturity date, risks and other necessary information) is indicated in the registration statement and prospectus of the relevant capital market instrument. The issuer must make a disclosure within five business days prior to the start of the term of the Partnership Warrant and provide information as to the time scale and other important issues regarding the exercise of the Partnership Warrant. The issuer has to comply with the public disclosure requirements of the CMB and disclose any material event that may occur during the term of the Partnership Warrant, and which may affect investors' decisions.

As per the Communiqué, the maturity date of the Partnership Warrants can vary between two months and five years. The holders of the Partnership Warrants must exercise the warrant within 30 days following the end of the maturity date. Otherwise, the warrant becomes worthless. If the holder exercises the Partnership Warrant during its term, the issuer company has to deliver the underlying shares to the investor, and the warrant, which is being registered in dematerialized form at the Central Registry Agency, is simultaneously cancelled. If the underlying instrument of the Partnership Warrant is the share of the issuer company, then the issuer company can only fulfill its delivery obligation by way of a capital increase.

Warrants finally enter the Turkish capital market as a new hope for enticing retail investors, who have been reluctant to invest in any capital market instrument during the economic slowdown in Turkey. Although it seems that it will take more effort to rebuild confidence in the equity and bond markets, it should still bring some action to the domestic market.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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