Definition and Legal Classification of Warrants
Warrants are transferable securities that grant the holder the right, but not the obligation, to acquire or dispose of a specified number of underlying assets (e.g. shares, commodities, or indices) at a predetermined price (‘exercise price’ or ‘strike price’) within a certain period. They thus represent derivative financial instruments and combine contractual claims with specific issuance conditions.
Under German law, warrants are governed by various statutory provisions, with key regulations found in the Securities Trading Act (WpHG), the German Civil Code (BGB), as well as the Regulation (EU) No. 600/2014 (MiFIR) and other EU directives.
Distinction From Related Financial Instruments
Distinction From Options
Warrants are similar to traditional options but differ particularly in that they are issued by a credit institution or another company, and can be traded as bearer securities. Whilst options are frequently traded on futures exchanges such as Eurex, warrants are subject to over-the-counter (OTC) trading or are offered as so-called securitized derivatives on regulated markets.
Difference to Subscription Rights and Option Certificates
In German parlance, warrants are often equated with option certificates, with option certificates being the generic term and warrants referring to a specific form thereof. Subscription rights, by contrast, grant the right to subscribe for new shares, whereas warrants usually concern the right to acquire existing securities.
Legal Nature and Contract Design
Contractual Structure Under the Law of Obligations
Legally, warrants embody a contractual relationship between issuer and holder, under which, in the event of exercise, the underlying asset is delivered or a cash settlement is made. The legal relationship arises upon purchase and booking of the warrant into the acquirer’s securities account.
Corporate Law Implications
Particularly in the case of equity warrants, exercise of subscription rights may have corporate consequences such as a capital increase or dilution of existing shareholdings, about which shareholders and corporate bodies are to be informed in accordance with the German Stock Corporation Act (AktG).
Issuance, Acquisition and Transfer
Issuance and Prospectus Requirements
Warrants are typically issued by banks or other issuers. Under the German Securities Prospectus Act (WpPG), they are regularly subject to the requirement of a prospectus, if they are publicly offered or included in trading on an organized market. The issue prospectus must include all relevant information about the function, risks, and contractual terms of the warrant.
Acquisition and Transferability
Trading in warrants takes place on exchange-traded or over-the-counter trading platforms. The transfer occurs in accordance with the rules of securities account trading and the Securities Trading Act. Ownership is documented by entry into the acquirer’s deposit account, whereby bearer securities are generally transferable without formality.
Functionality and Types of Warrants
Call and Put Warrants
- Call Warrants grant the right to purchase the underlying asset at the exercise price (‘long position’).
- Put Warrants certify the right to sell the underlying asset at the exercise price (‘short position’).
Types of Exercise
- American Warrants: Exercise is possible at any time up to the expiry date.
- European Warrants: Exercise is only possible on the final date.
Physical Delivery and Cash Settlement
Depending on their structure, a warrant may provide for the underlying asset to be physically delivered upon exercise (physical settlement), or for a cash settlement in the amount of the difference between the market price and the exercise price (cash settlement).
Rights and Obligations of the Parties
Rights of the Holder
The holder has a certified right of exercise, but no obligation. Further rights (such as rights to information, dividend entitlements, or voting rights in the case of equity warrants) generally do not arise unless they are expressly agreed by contract.
Obligations of the Issuer
The issuer is obliged, upon exercise by the holder, to fulfill the services certified in the warrant, i.e. either to deliver the underlying asset or to provide a cash settlement. Compliance with statutory requirements, particularly regarding obligations to provide information and risk disclosure, is mandatory.
Legal Protection and Risks
Investor Protection
The distribution of warrants is subject to strict investor protection rules, particularly in the Securities Trading Act (WpHG), through the requirement to provide appropriate information about opportunities and risks as well as the right to access all relevant information about the warrant itself and its issuer.
Aspects of Insolvency Law
In the event of the issuer’s insolvency, the warrant holder is treated as an unsecured creditor. Claims arising from warrants are generally treated as unsecured claims, so that in the event of insolvency there is a significant risk of (partial) loss of claim.
Tax Treatment
Profits and losses from warrants are, under German tax law, generally to be taxed as income from capital assets (final withholding tax). The specific tax treatment depends on individual circumstances and the relevant legal regulations.
Regulatory and Supervisory Framework Conditions
Admission to Trading
Admission of warrants to regulated markets requires compliance with the applicable regulations of the respective exchange and the approval of the competent supervisory authority, in particular the Federal Financial Supervisory Authority (BaFin).
Transparency and Reporting Obligations
Issuers as well as market participants are subject to extensive reporting and publication obligations in order to prevent market manipulation and insider trading. Compliance with these obligations is a core component of regulatory requirements in the area of structured securities.
International Aspects
European Law and Cross-Border Sale
In addition to German regulations, European legal provisions also apply to warrants within the European Union, such as those from the MiFID II Directive and the EU Prospectus Regulation. This particularly concerns admission to public distribution and cross-border trading.
US Law
The issuance of warrants in the USA is subject to the regulations of the U.S. Securities and Exchange Commission (SEC), in particular the Securities Act of 1933. In the case of cross-border issuances, the relevant national legal requirements must also be observed.
Conclusion
As securitized derivative financial instruments, warrants constitute a versatile and complex legal structure under capital market law. They enable the holder to pursue flexible investment strategies but require a detailed understanding of the legal framework and conscientious risk management. Both issuers and acquirers should carefully observe statutory requirements, in particular with regard to obligations relating to information, disclosure, and documentation, to ensure legally compliant trading and effective investor protection.
Frequently Asked Questions
How are warrants legally classified in the German legal system?
Under German law, warrants are generally regarded as financial instruments within the meaning of the Securities Trading Act (WpHG). Since warrants are securitized options, they are subject to regulations concerning securities trading, prospectus requirements, insider trading, and market abuse. Legally, §§ 2 and 2a WpHG are particularly relevant, as they define warrants as derivative financial instruments. During the issuance process, warrants that are publicly offered are also subject to the prospectus requirement under the Securities Prospectus Act (WpPG). Special attention is paid to consumer protection law, particularly regarding distance contracts and advisory records under § 34 WpHG. In the case of securities lending or trading via multilateral trading systems, other rules such as MiFID II and the relevant provisions of the Federal Financial Supervisory Authority (BaFin) also apply. Tax implications, for example with respect to capital gains tax under the Income Tax Act (EStG), must also be considered.
What information and disclosure obligations apply to issuers and intermediaries of warrants?
Issuers of warrants and intermediaries (e.g., banks, brokers) are subject to extensive information and disclosure obligations toward their clients. According to §§ 63 ff. WpHG, all information relevant to the investment decision regarding opportunities, risks, functionality, as well as the financial background and costs of the warrants must be disclosed in a timely and comprehensible manner. For public offerings, a prospectus reviewed by BaFin in accordance with § 3 WpPG must be presented, describing all key features of the warrant as well as any risks, especially those relating to the risk of total loss. When advising retail clients, the appropriateness and suitability of the investment service must also be demonstrated as part of a so-called suitability assessment (§ 64 WpHG). Violations of these obligations can result in civil claims for damages and regulatory sanctions.
To what extent are warrants subject to a prospectus requirement?
Warrants that are publicly offered or admitted to an organized market are generally subject to the prospectus requirement under the Securities Prospectus Act (WpPG). The issuer must publish an approved prospectus containing all relevant information about the securities and the respective risks. There are only a few exceptions from the prospectus requirement, such as when the offer is made exclusively to qualified investors or to fewer than 150 persons per Member State within twelve months (§ 3 para. 2 WpPG). The prospectus requirement is intended to ensure transparency and protect investors from information asymmetry. Disregard of this requirement may result in both civil claims by acquirers and regulatory action by BaFin.
How are warrants treated legally in the event of the issuer’s insolvency?
In the event of the issuer’s insolvency, warrants form part of the liabilities side of the insolvency estate. Since they are debt securities, warrant holders can generally only register their claims as unsecured insolvency creditors for the insolvency table. Unsecured warrants are usually subordinated in payment and are subject to the risk of total loss, unless there are separate security mechanisms (e.g., trust or escrow arrangements). Statutory deposit protection schemes generally do not apply to warrants, as they do not constitute deposits within the meaning of the German Deposit Protection Act (EinSiG). The legal situation should therefore be examined in each individual case, particularly on the basis of the terms of issue and any contractual security mechanisms.
What special features apply to the tax treatment of warrants?
The tax treatment of profits and losses from warrants in Germany is governed by the provisions of the Income Tax Act (EStG). In principle, income from trading in warrants is considered income from capital assets (§ 20 para. 2 EStG). Gains and losses are taxable at the rate applicable for the final withholding tax of 25% (plus solidarity surcharge and, if applicable, church tax). Losses can be offset within the framework of capital loss offsetting pursuant to § 20 para. 6 EStG, however, there are restrictions with regard to offsetting against other capital gains, as losses from derivative transactions, to which warrants may also belong, are only deductible to a limited extent (loss compensation pool). For corporate investors, the general profit determination rules apply (e.g., § 4 or 5 EStG). Deviations may also result from double taxation agreements or special investor constellations.
Is there any special regulation for the secondary market in warrants?
Trading in warrants on the secondary market is comprehensively regulated. Platforms on which warrants are traded are supervised by BaFin and subject to the relevant provisions of the Securities Trading Act and MiFID II. This especially concerns requirements for transparent price formation, prevention of market manipulation, and rules for exchange trading and over-the-counter (OTC) trading. The acquisition and disposal of warrants via banks or online brokers are accompanied by stricter reporting and documentation requirements. There are also special rules for preventing insider trading and market abuse under the European Market Abuse Regulation (MAR). Investors are entitled to transparent price information and proper order execution in accordance with § 82 WpHG.
What legal risks exist in acquiring warrants?
Acquiring warrants is associated with various legal risks. Apart from the general issuer risk, i.e. the possibility of (partial) loss in case of insolvency, there are risks concerning transparency, incorrect or incomplete advice, and potentially misleading product information. Furthermore, there is a risk of not receiving the underlying asset properly or on time, for instance due to technical or legal problems in the settlement process. Regulatory changes may also affect existing rights and obligations of investors. In exceptional cases, government intervention, such as a trading ban or delisting, may result in early payout or expiration of the warrant. In cross-border acquisitions, different national interpretations and enforcement of the law may also play a role. Investors should therefore always carefully examine the terms of issue and seek legal advice in case of doubt.
