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Plans for a more sound warrants market

Se-Jin Kim

The Korean Financial Supervisory Service and the Korea Exchange (KRX) have announced solutions to various problems associated with the growing equity-linked warrants (ELW) market. Following the initial announcement by the Service in May 2011 which promised a number of measures designed to create a more stable environment for the market, KRX released a public notice on June 14 setting out specific changes which will be made to the applicable regulations. Some important aspects of these proposed changes are as follows:

Stronger protection for investors:

A base deposit of W15 million ($13,800) is required for both new and existing ELW investors.

KRX listing guidelines will be revised to place restrictions on the issuance of deep-out-of-the-money ELWs (for example issuance of ELW with parity of less than 85% to be prohibited.)

Encourage formation of fair market price:

KRX will regularly announce the index ELW premium ratio for all liquidity providers, in an attempt to narrow the price disparity between index options and index ELWs.

In order to enable easier comparisons between index options and index ELWs, KRX will only approve issuance of ELWs whose final trading day is identical to the option maturity day, with the conversion ratio set at 100 and interval of exercise prices set at 2.5 points.

The weight given to the implied volatility category in assessing liquidity provider performance is to be increased from the 10% to 20%.

Improved order routing speed:

Brokerage firms generally are, and will continue to be, permitted to provide services which offer convenience to investors, such as setting up dedicated order processing systems or lines. However, brokerages will be prohibited from installing an order processing system for scalpers which allows order to divert the brokerage firms' firewalls.

KRX regulations will be improved to ensure that quotations can be submitted to KRX in the order that the brokerages receive and process them.

Se-Jin Kim and Steven Lee

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