UAE Securities and Commodities Authority publishes Decision No. 2 of 2014 on the Regulation of Covered Warrants

The above regulations in respect of covered warrants have come into effect in the UAE, enabling licensed issuers to issue and trade covered warrants on exchanges outside the free zones in the UAE (the Regulations). The Regulations demonstrate an increasing commitment to developing the UAE onshore capital markets, with some speculating that this is a precursor to the introduction of regulations for other more complicated instruments such as options and futures.

What is a covered warrant?

Covered warrants are a form of listed security issued by financial institutions that are traded on stock markets. Depending on how the warrant is structured, it gives the holder the right, but not the obligation, to buy or sell an underlying asset (such as shares, commodities or currencies) at an agreed price on or before a set date. The price paid for this right is often referred to as the "premium" payable for the covered warrant and the holder cannot lose more than any such premium he has paid. Covered warrants are generally seen as a flexible investment option for private investors who are looking for instruments which can offer the leverage benefits of a derivative but with a lower risk profile.

When an issuer sells a warrant to an investor, it typically limits its risk by buying the underlying instrument in the market. Under the Regulations, the Securities and Commodities Authority (SCA) may approve the issue of warrants without requiring the issuer to purchase the underlying asset, provided the issuer evidences sufficient solvency to cover the value of the issue or proof that the issue is guaranteed by another body, bank or financial institution which itself meets the SCA's solvency requirements.

Who can issue covered warrants?

The issuer must be licensed by the SCA and must satisfy certain conditions listed in the Regulations in order to obtain such licence, including that it shall:

  • be either: (i) a commercial or investment bank, financial institution or branch of a foreign bank, in each case which is licensed by the Central Bank to issue covered warrants; or (ii) a company or body established in accordance with the UAE Commercial Companies Law and licensed by the SCA to work in the securities sector;
  • have a minimum capital of not less than AED100 million; and
  • have efficient risk management, compliance and disclosure systems in place.

The licence shall be issued on an annual basis, expiring every December. The period of the first licence shall start from the date it is granted until the end of December of the same year.

Continuing obligations

Once the issuer is licensed to issue covered warrants, it has certain continuing obligations, including to:

  • submit annual audited financial statements and notify the market of any deficit which may affect its financial position;
  • permit the SCA access to any information and/or documentation it requires in order to carry out its regulatory function;
  • act with honesty and sincerity;
  • appoint a market maker licensed by the SCA for any covered warrants issued by it, or obtain the authorisation of the SCA to act as its own market maker;
  • submit a monthly report to the SCA which is to include details of the total amount of issued covered warrants, the number of purchased or sold warrants and the average purchase or sale price; and
  • disclose immediately to the SCA and the market any substantial developments that may affect the price of the covered warrants.

Issuing and listing covered warrants

Each issue and listing of covered warrants must be approved by the SCA. The following key conditions must be met in order to obtain such approval:

  • the issuer must demonstrate that it is able to fund the value of the issue - either by evidencing sufficient solvency, providing proof that the covered warrants are guaranteed by another financial institution that meets the SCA's solvency requirements or depositing the underlying assets either with the market clearing house or with an independent trustee licensed by the SCA;
  • a prospectus must be issued setting out the details in respect of the issue, such as the warrant price, warrant type, execution price, conversion rate, settlement method (cash/in kind), method of calculation of the settlement price, the date specified for the expiry of the warrant and the minimum allocation, if any;
  • a minimum of one million covered warrants must be issued corresponding to one million underlying assets;
  • the issuer is responsible for pricing all covered warrants;
  • the underlying asset must be tradable in the relevant market and convertible without restriction;
  • where the underlying assets are shares, the total number of warrants to be issued (taking into account any warrants which have already been issued and are still valid) shall not exceed 50 per cent of the total number of shares of that company; and
  • where it is mandatory to disclose the ownership of the underlying assets, the issuer must demonstrate a means to disclose the ownership of the relevant covered warrants.

There remain certain details to be finalised in respect of the issue and licensing of covered warrants, such as the licensing fees and regulations relating to market makers. The Regulations provide for the relevant markets to issue regulations in respect of these further matters, subject to the approval of the SCA.

Settlement

Covered warrants are settled once the owner exercises the right granted to him. Settlement can be in cash or in kind according to the method of settlement provided for in the prospectus. However, the Regulations provide that settlement must be in cash in certain circumstances, such as:

  • if the underlying assets are issued outside the UAE or in a free zone inside the UAE; or
  • if the underlying assets are shares, settlement would breach the foreign ownership restrictions set out in the UAE Commercial Companies Law such that the UAE national ownership of the company would fall below 51 per cent.