Interconnection Trading System Warrants, Certificates and other products MARKET MODEL DESCRIPTION January 2015
TABLE OF CONTENTS 1. INTRODUCTION 4 1.1. Background 4 1.2. Institutional market configuration 4 1.3. Market model structure 4 2. PRODUCTS 6 2.1. General product description 6 2.2. Warrants 6 2.3. Certificates 8 2.4. Turbos / Turbos Pro 9 2.5. Bonus / Bonus Cap 9 2.6. Inlines 10 2.7. Discounts 10 2.8. StayHigh / StayLow 11 3. MARKET PHASES AND SCHEDULES 11 4. MARKET SEGMENTS 11 4.1. Main Market 12 4.2. Blocks 12 4.3. Special Trading 13 5. ORDER TYPE 13 5.1. Standard order type 13 5.2. Quote Order 14 6. PRICE UNITS (TICK SIZE) 15 7. AGENTS INVOLVED IN THE MARKET 15 7.1. Issuers 15 7.2. Brokers-dealers, brokers and financial institutions 16 Sociedad de Bolsas, S.A. 2
7.3. Specialists 16 8. BASIC TRADING RULES 17 8.1. Open market. Basic trading rules 17 8.2. Auctions. Equilibrium price fixing rules 17 9. VOLATILITY AUCTIONS AND PRICE RANGES 18 9.1. Volatility auctions 18 9.2. Dynamic Price and Dynamic Range 19 10. INFORMATION DISSEMINATION 19 Sociedad de Bolsas, S.A. 3
1. INTRODUCTION 1.1. Background On 11 November 2002, the SIBE (Spanish Stock Exchange Interconnection System) introduced the Warrants, Certificates and Other products module to admit financial products different to those traded on SIBE before this date, as described briefly in this document. Securities that began to be traded under the new module came from the Fixed-Income system of the Madrid Stock Exchange, where they had been traded up to then. The launch of the Warrants, Certificates and Other products module is due to the growing demand for these products in Spain and in Europe, and the request of issuers that work in Spain for a dynamic, flexible and technically solid market designed specifically for these products in our country. 1.2. Institutional market configuration The institutional configuration of these Warrants, Certificates and Other products market does not differ to the traditional stock market in its main stakeholders. As with this latter market, the Warrants, Certificates and Other products market is part of the Stock Exchange Interconnection System (S.I.B.). The institutional structure is constituted by traditional stock market stakeholders (market participants under the form of Securities Brokers, Brokers/Dealers and Financial Institutions) as well as two essential figures of this new module: Issuers and Specialists 1.3. Market model structure This document is divided into different sections with the intention of providing a view of the new module implemented in the S.I.B for Warrants, Certificates and Other products as a Sociedad de Bolsas, S.A. 4
whole. Below you will find a description of the section content in the order that they appear in this document: The first section named PRODUCTS gives a general view of how the different asset types included (or that may be included) in this module work with a description of some basic concepts of the same in relation to Warrants, Certificates and Other products. MARKET PHASES AND SCHEDULE describes the trading phases that this module has during a session and how it is structured. You will also find the current schedules for each stock exchange within the specific Warrants, Certificates and Other Products module. In MARKET SEGMENTS, the trading of each module segment is specified and the characteristics of each market segment are described, namely: main market, blocks and special trading. ORDER TYPE describes the type of orders that may be entered in the system. There is also a specific section for quote orders. PRICE UNITS (TICK) clarifies what the minimum price variation is for securities traded in this module. AGENTS INVOLVED IN THE MARKET provides an unexclusive classification of the main stakeholders involved in this module in its various phases. It particularly goes into detail in the role that Issuers and Specialists play in this market. BASIC TRADING RULES section explains in detail the rules that govern the market distinguishing between two very different periods: the auctions (equilibrium price fixing rules) and the open market (basic trading rules). VOLATILITY AUCTIONS AND PRICE RANGES is the section that explains price variation management based on volatility auctions and price ranges. The basic Sociedad de Bolsas, S.A. 5
concepts of this management are defined INFORMATION DISSEMINATION explains the specialized information flow content provided in detail taking into account that this is an anonymous market (the information on the buyer and seller is not disclosed in order book or in trade log). 2. PRODUCTS 2.1. General product description The Warrants, Certificates and Other products module is designed in order to incorporate various financial product types that have in common their evolution and valuation linked to an underlying asset that may be a share, an index, a basket of shares or indexes, raw materials, exchange rates or interest rates among others. Similarly, these products usually have an expiration date. In addition, they are all traded, cleared and settled like shares. The features of each individual product are defined in the following sections: 2.2. Warrants A warrant is a tradable security issued by an institution 1 for a time period that gives the right (and not the obligation) by paying a price to buy (call warrant) or to sell (put warrant) a specific amount of an asset (underlying asset) at a specified price (strike) over the duration of its life or on its expiration date depending on its style. From this short definition, some basic concepts are taken and defined as follows: Time period: This refers to the warrant s expiration date, which indicates the date from when the warrant no longer exists. The expiration date may or may not 1 The institution that issues the warrant is the Issuer which will be discussed in more detail in the section called Agents involved in the market. Sociedad de Bolsas, S.A. 6
coincide with the warrant s last trading day in the Stock Exchange Interconnection System. Warrant price: This is the premium, that is to say, the effective price on what trades are executed on the Stock Exchange Interconnection System. The premium will be closely tied to the price evolution of the underlying asset related to the warrant. Call warrant: this is a purchase warrant, that is to say, it gives the right to buy the underlying asset. Put warrant: this is a sales warrant, which gives the right to sell the underlying asset. Ratio: This is the number of underlying asset units that a warrant gives the right to buy (call) /sell (put) 2. Strike: Established by the Issuer, it is the price at which the holder has the right to buy (call) / sell (put) the underlying asset at the time of exercising the warrant 3. Style: A warrant can be American-style or European-style. If the warrant is American, it may be exercised during the warrant s life. On the other hand, if it is European, it can only be carried out on the warrant s exercise date. Previously, in the paragraph on warrant price, we said that the premium evolution is closely linked to the underlying asset price. Below, and without going into exhaustive detail, we have illustrated how to relate the investor s position in relation to risk in accordance with his/her expectations on the future evolution of the underlying asset price, basically taking into account whether it is a call warrant or a put warrant. 2 There is also the reverse concept, called Parity: number of warrants necessary for the right to buy (call) / sell (put) a specific number of underlying assets. 3 Exercising a warrant is when the warrant holder exercises his/her right to buy (call warrant)/ sell (put warrant) the underlying asset that the warrant refers to. Exercising a warrant involves its settlement, either by physical delivery of the underlying asset or cash (in euro). The S.I.B. applies the latter method. Sociedad de Bolsas, S.A. 7
Buyer warrant call Seller warrant call Profits ( + ) Profits ( + ) Underlying asset price Premium Premium (1) Underlying asset price Losses ( - ) Losses ( - ) Buyer warrant put Seller warrant put Profits ( + ) Profits ( + ) Underlying asset price Premium Premium Underlying asset price Losses ( - ) Losses ( - ) The above graphs, well known in basic literature on options, are easy to read and we will only look at the following example: Specifically, a call warrant buyer (first graph) pays a premium to buy the warrant (a right that when exercised means acquiring the underlying asset). Premium payment is shown in the graph as a loss (in the sense that it is an expenditure for the buyer). As the underlying asset increases higher than the exercise price, the call warrant holder is in a more advantageous position (his/her profits are increasing) as s/he has the right to buy the underlying asset at the exercise price which is lower than the price that this underlying asset is trading at in the market (graph (1) price). 2.3. Certificates Certificates authorize their holder to receive from the issuer on the settlement date a determined amount on the certificate nominal value in accordance with the underlying asset variation. Specifically, the holder directly assumes the profit or loss in accordance with the underlying asset evolution. Given the certificate s nature, it is based on an initial underlying asset price and in accordance with its evolution; the returns to be obtained for the certificate are produced upon its expiration date or on the exercise dates. Sociedad de Bolsas, S.A. 8
The final returns on certificates depend on the investment strategy and performance of the underlying asset. 2.4. Turbos / Turbos Pro Turbo Warrants may have early termination in relation to the expiration date established in the issue conditions. The early termination possibility is determined by a barrier level. When the underlying asset price reaches or exceeds the barrier level, the Turbo Warrant is terminated early (knocked-out). In the case of Turbo Call warrants, early termination is produced if the Underlying Asset level is less than or equal to the barrier established in the issue conditions. In the case of Turbo Put warrants, early termination is produced if the Underlying Asset level is more than or equal to the barrier established in the issue conditions. When the aforementioned conditions are met, Turbo Warrants terminate early without any value and are delisted. Taking the previous information into account, Turbo Warrants are characterized by high leverage that is reflected in the premium level (or Turbo Warrant price). Similarly, its price evolution is mainly determined by the underlying asset price evolution and not so much by its volatility or expiration term. Within this same product category, we also find the so-called Turbo Pro. These incorporate two thresholds (knock-in barriers) that form an activation price range. Therefore, Turbo Pros will remain inactive in the market until the level of the underlying asset trades within the mentioned range. Once activated, Turbo Pros act as any other Turbo. 2.5. Bonus / Bonus Cap Bonus warrants offer the performance of its underlying asset and, as long as the level of the latter does not reach a determined lower barrier during the lifecycle of the product, the issuer Sociedad de Bolsas, S.A. 9
guarantees a minimum selling price or bonus. Therefore, if the level of the underlying asset reaches this lower barrier, then the Bonus Warrant loses its bonus guarantee but remains active on the market. Within this same product category, we also find the so-called Bonus Cap. These incorporate a limit to the potential upside performance of the product that is placed at the same level of the bonus guarantee, whether it is still active or not at its expiration date. 2.6. Inlines This type of warrant grants the right to receive a fixed amount of money on the expiration date, assuming that the value of the underlying asset is still within the limits or established barriers. Inline warrants have both an upper and lower barrier between which the underlying asset s price must stay during its lifecycle. If the underlying asset s price touches either of the barriers, the inline warrant will expire automatically without value. 2.7. Discounts The Discounts are investment products, with the characteristic of offering a maximum return calculated from the difference between the upper and lower barriers. They can be either bullish, Call Discount, or bearish, Put Discount. The Call Discounts offer a maximum yield when the level of the underlying asset is equal or higher than the upper barrier on the maturity date, or whenever it has remained above the lower barrier during the entire life of the product. If it breaches the lower level the product will remain active in the market but it will no longer deliver the maximum yield unless the first previously described circumstance occurs. If at maturity the underlying asset is below the lower barrier, the Discount would be worth 0. The Put Discount has a similar behaviour but in reverse. Sociedad de Bolsas, S.A. 10
2.8. StayHigh / StayLow The StayHigh and StayLow Warrants incorporate a mechanism of knock-out that offers the holder of the product a potential settlement of 10 Euros: The holder of the StayHigh will receive the maximum settlement if during the life of the product the price of the underlying asset is above the lower barrier predetermined. The warrant will be deactivated if the price of the underlying asset reaches the lower barrier, in which case its value will be 0. The behaviour of the StayLow is similar but in the opposite direction. The holder of the warrant will receive the maximum settlement if the price of the underlying asset is below the upper barrier. In case it exceeds this upper barrier, its value will be 0. 3. MARKET PHASES AND SCHEDULES Market phases in an ordinary session are structured from the Continuous Trading (its schedule is from 09:00 to 17:30) during which there may be Volatility Auctions (one or several securities) that originate from the actual market (depending on prices introduced in the market 4 ) or those exceptionally generated from the Supervision Department if deemed necessary due to circumstances of a security or group of securities. On the other hand, during the same schedule as Continuous Trading, (from 09:00 to 17:30) blocks can be executed under a specific segment. In addition to this Ordinary session period, there is the Special Trading 5 phase that occurs from 17:40 until 20:00. 4. MARKET SEGMENTS The market is made up of three segments: the main market, blocks and special trading. 4 See section: Volatility Auctions and Price Ranges for a detailed explanation of the original of Volatility Auctions in accordance with the dynamics of the order book itself. 5 For a more detailed explanation of the type of trading dealt with during this period, see the following section called Market Segments in the section corresponding to Special Trading. Sociedad de Bolsas, S.A. 11
4.1. Main Market The Main Market is the general trading segment. This deals with carrying out ordinary trading and it is structured by the order book that is continuously updated in accordance with order entries, trades, modifications and cancellations. It is in this Main Market where, as we said in the previous section, there is a continuous trading period that may be temporarily interrupted by Volatility Auctions on one or several securities. It is also where the official trading prices pronounced by Sociedad de Bolsas are ultimately agreed. In the Main Market during the open market period, the order book is public (the best bid and ask prices can be seen) however it remains anonymous (neither buyer nor seller participating in each side can be identified nor the trades that take place). With regard to auction periods, the order book only shows the balance price calculated at all times. The open session ends without auction at 17.30, being the closing price of the session the midpoint between the best bid and ask positions held by the specialist of the security, rounded up. In the absence of these positions or if the closing price is outside the security s dynamic range or the security is suspended from trading, the closing price shall be the price of the last trade in the session. In the absence of the above, the closing price shall be the reference price of the session. 4.2. Blocks This segment deals with the execution of fixed price trading of a high number of securities. The justification of this segment is based on the opportunity of negotiating large volumes with a maximum percentage deviation on market prices, thereby avoiding market price distortion of the security in question. Sociedad de Bolsas, S.A. 12
Nevertheless, the blocks (trades or cross trades of a large number of securities) have certain price and volume conditions that need to be followed for their execution 6. Specifically, they need to reach minimum 50,000 euro. With regard to price requirements, the price range that the block can be executed on is the maximum and minimum limit marked by the dynamic range in relation to the current dynamic price of the security in question at all times. 4.3. Special Trading The special trading segment has a schedule that runs from 17:40 to 20:00. During this period, trades (or cross trades) are executed at a set price and they may be Communicated or Authorized 7. As with block execution, special trading needs to meet price and volume requirements for their execution 8, although these requirements are different to those for the block segment. 5. ORDER TYPE 5.1. Standard order type The Warrants, Certificates and Other products module only allow limit orders. Limit orders: on the open market, these are orders to be executed at their limit price or better. Buy orders are executed at this price or at a lower price on the opposite side of the order book. Ask orders are executed at their limit price or at a higher price on the opposite side of the order book. These orders allow: 6 An additional requirement for a block to be executed is: at the time of the execution the security cannot be in auction, suspended or interrupted. 7 The difference between the two trading types is that while those Communicated only need to be within certain price and volume parameters. The Authorized trading requires authorization from the Trading and Supervision Commission on the basis of documentation provided by the participants intervening in that trade. 8 The applicable regulation on special trading is contained in the Circular 1/2001 of Sociedad de Bolsas ( Operating regulations of the Stock Exchange Interconnection System ). Sociedad de Bolsas, S.A. 13
- To express the wish to trade up to/ from a certain price. - To execute an order against existing orders on the market at a price that is not worse than the limit price and to leave the rest on the market at the limit price. These orders may be entered both on the open market and during auctions. Limit orders, on the open market are executed at the best opposite-side prices on the order book (provided that these prices are equal to or better than the price of the incoming limit order). Once in the order book, the limit order is always executed at its limit price (unless it is included in an auction and the auction price is better than its limit price). They all have a one day validity period, so they are all valid until the end of the session that is taking place. This means that non-traded or partially traded orders are automatically removed from the system after the session ends. With regard to the trading capacity, there is a difference between acting on its own account, as an agent for a customer or as a market specialist. 5.2. Quote Order The quote order is an instrument provided to the specialists so that they can give liquidity to the market more easily and efficiently than through simple orders. identity. The SMART quote order is made up of two individual orders, each one with its own Each user may only have one quoted order active per security. Quoted orders can be traded at all times against simple orders and may activate auctions just like any other order. Sociedad de Bolsas, S.A. 14
6. PRICE UNITS (TICK SIZE) Price units or tick size (minimum variation between two different prices on the same security) in the Warrants, Certificates and Other products module is 0.01 euro irrespective of the price that the security has. Any price expressed with maximum 4 whole and 2 decimal numbers is accepted. 7. AGENTS INVOLVED IN THE MARKET There are several types of agents involved in this market, particularly if we look at the different market stages, starting when a new security is issued until a trade is crossed on it. We can make three main categories of agents in accordance with the functions that each one does: Issuers. Brokers-dealers, brokers and financial institutions Specialists. All of these agents are subject to supervision, inspection and control by the Comisión Nacional del Mercado de Valores (CNMV) in everything related to securities market performance. The CNMV is the public agency whose purpose is the regulation, supervision and inspection of the securities market and of the activities of all individuals and legal entities that participate in it. 7.1. Issuers Issuers provide the securities that will trade in the Warrants, Certificates and Other products module once authorized by CNMV provided that all formal requirements are met. In fact, a warrants issue often includes several securities (they can exceed 500) and it needs to pass several legal requirements before being listed: 1. Issue notification to the CNMV. 2. Previous delivery and registration of documents accrediting issue agreement, characteristics of securities to be traded, and holders rights and obligations. Sociedad de Bolsas, S.A. 15
3. Verification and registration of issuer s audited annual reports and prospectus on projected issue. 7.2. Brokers-dealers, brokers and financial institutions Brokers-dealers, brokers and financial institutions are the traditional participants in the equity markets of the Spanish Stock Exchanges Governing Bodies. These market participants are the link that the final investor can use to enter orders in the SMART platform. The main difference between these institutions is that brokers can only trade on behalf of third parties while broker-dealers and financial institution can trade on behalf of third parties and on their own behalf. 7.3. Specialists The Specialists carry out an essential role in the Warrants, Certificates and Other products module, especially regarding the daily quotation of bid and ask prices and volumes. Each security is required to have a specialist and there can only be one specialist per security. With regard to the role of these Specialists, it is necessary to point out that while this module is similar in its trading method to the typical order book, being an order-driven one, its liquidity is guaranteed by these Specialists in such a way that this order book is complemented with their role. On the other hand, as previously mentioned, these Specialists have a new dynamic and simple tool for quoting bid and ask prices on the market: the quoted order. The Specialists must comply with the applicable regulation on specialists at all times 9. 9 The applicable regulation on specialists in the Warrants, Certificates and Other products modules is contained in the Circular 1/2002 of Sociedad de Bolsas ( Operations Regulations of the negotiation segment of Warrants, Certificates and Other products in the Stock Exchange Interconnection System ) and in the Trading Instruction No. 53/2002 ( Special presence parameters in the negotiation segment of Warrants, Certificates and Other products ). To be concise, the regulation speaks about requirements for maximum range, minimum effective amount and reaction time. Sociedad de Bolsas, S.A. 16
8. BASIC TRADING RULES 8.1. Open market. Basic trading rules traded. During the open market, orders are entered, modified and cancelled; and when applicable The open market situation in the Warrants, Certificates and Other products module is going to be the most usual situation (unless there is an extremely volatile situation where many volatility auctions take place on several securities or there is an auction on a determined security for exceptional reasons). During this period, there are several basic rules to follow (same as in the equity market) and these are summarized in the following points: Price-time priority of orders: orders with the best price (highest bid and lowest ask) have priority in the book. When prices are the same, those orders entered first have priority. Best opposite side price: orders entered in the system are executed at the best opposite side price. In other words, a buy order which can be executed will do so at the price/s of the first order/s on the sell side of the order book. Equally, an ask order entered in the system which can be executed at that moment will be executed at the price/s of the first order/s on the buy side of the order book. In addition, it is necessary to point out that orders may be fully executed (in one or several trades), partially executed, or may not be executed. Therefore, each new incoming order may generate several trades. 8.2. Auctions. Equilibrium price fixing rules Auctions are periods when orders are entered, modified and cancelled but trades do not take place until the end of this auction. During this period, and in real time, an equilibrium price is calculated in accordance with the supply and demand leading to trades at the end of the auction at the last equilibrium price calculated (securities allocation). Sociedad de Bolsas, S.A. 17
With regard to equilibrium price fixing rules that govern in auctions, there is no difference to those that govern the equity market, and they are established in accordance with the following four rules: 1) The price that would produce the trade of the highest number of securities is chosen. 2) If there are two or more prices at which the same number of securities can be traded, the auction price shall be that which leaves the smallest surplus. The surplus is defined as the difference between the volume offered and the volume in demand to be traded at the same price. 3) If the two above conditions are met, the price on the side with higher volume (more weight) will be chosen. 4) If the three above conditions are met, the one closest to the last one traded will be chosen as the auction price. In the event that this price is within the auction potential price range (highest and lowest limit), the last one traded will be taken. If there is no last price, or it is not within the price range of the dynamic range, the price closest to the reference price will be taken as the last price. 9. VOLATILITY AUCTIONS AND PRICE RANGES 9.1. Volatility auctions The duration of Volatility Auctions in the Warrants, Certificates and Other products module is 5 minutes plus a random end of 30 seconds during which the auction ends at any time and without prior notice, and the securities allocation process takes place (cross trading at the equilibrium price in the auction sale). If upon market closing, there is one or several securities in auction, the system will automatically allocate them at session closing (17:30). Volatility Auctions will take place due to dynamic range rupture. Sociedad de Bolsas, S.A. 18
9.2. Dynamic Price and Dynamic Range is established. In the Warrants, Certificates and Other products module, only a range type called dynamic At the start of the session, the updating of the dynamic price with which the dynamic range is applied is regarding the reference price. During the session, the dynamic price and range is applied regarding the last price traded; whether the execution of the incoming order is in the open market or the result of a volatility auction. The dynamic range is defined as the maximum variation permitted (symmetric) with regard to the dynamic price and it is expressed as a percentage. For warrants, the dynamic range levels are determined by the warrant price as follows: Securities with price less than 0.10 euro: 500% Securities with price more than or equal to 0.10 euros and less than or equal to 1.00 euro: 50% Securities with price more than 1.00 euro: 15% In the case of certificates and Structured Bonds, the range will be 15%. For Turbo warrants, the dynamic range applicable will be 500%. For Other products, the dynamic range applicable will be 500%. The Volatility Auction takes place when there is an attempt to trade a security outside of the limits defined by the dynamic price range. If the price from a volatility auction is not within the dynamic range, the auction will be automatically extended and the Supervision Department will be in charge of taking the necessary measures to resolve the matter. 10. INFORMATION DISSEMINATION The SMART platform that supports the Warrants, Certificates and Other products module disseminates detailed information in real time, both trades that are going on and the system s Sociedad de Bolsas, S.A. 19
order book. In this way, this information flow informs the recipient institutions of each trade that is taking place in the market in real time and of the order book evolution during the session. The following content is offered: Trades: a message is issued each time there is a trade in the system. Information regarding the price, volume and trade time is given (buyer and seller of this trade do not appear). Order Book: a message is issued each time there is a change in the best five (5) bid and/or ask positions. Sociedad de Bolsas, S.A. 20