Self-funding instalment warrants

Technical resource

Self-funding instalments allow investors to gain exposure to securities by making a part payment upfront and delaying a final payment (which is optional) until a later date.

How do they work?

  • The initial payment is generally approximately 50% of the underlying share price and includes an interest cost, put option fee and borrowing fees.

  • The put option gives investors the option to sell the underlying asset at an agreed price upon maturity back to the provider, so there’s no obligation to make the final payment. Instalment warrants are a type of limited recourse loan as the lender’s rights in the event of default by the borrower are limited to the shares. There’s no access to the other assets of the borrower.

  • Further payments are generally not required during the investment term.

  • Due to the convenient ‘self-funding’ feature, investment cash flows are automatically managed. This means interest is automatically added to the loan on 30 June each year while dividends and any reimbursements of pre-paid interest go to reduce the loan.

  • The final payment represents the outstanding loan amount payable to the issuer.

  • Completion date is the date the outstanding loan is repaid and legal ownership of the shares passes to the investor.

What are the benefits?

  • Leverage - by purchasing a self-funding instalment an investor pays a fraction of the price of the underlying asset and receives the full benefits of the underlying asset as if they had paid in full.

  • Diversification - as less capital is required to buy a self-funding instalment, greater exposure to the underlying asset is achieved. Cash can also be extracted from an existing security through a self-funding instalment to invest in other assets.

  • Automatic cash flows - the franking credits and dividends paid are used to reduce the loan amount automatically.

  • Cash extraction - it’s possible to unlock cash from existing holdings and convert existing securities to self-funding instalments without triggering capital gains.

  • Liquidity - self-funding instalments are ASX listed, allowing their sale or purchase at any time during normal market hours.

  • Potential tax benefits - prepaid interest may be deductible (subject to a benchmark cap, refer to protected equity loans for more information).

  • Limited recourse, with potential loss restricted to borrowing costs prior to exercising the put option.

What are the risks?

  • Self-funding instalments increase exposure to a given security, which means while returns may be heightened, losses may also be magnified (subject to the cap provided by the put option).

  • Financial performance of listed entities. The amount of any dividends paid by the underlying securities and applied towards the reduction of the loan is dependent on the listed entities’ financial performance and may decline. As a result, the loan might not be paid down to the extent anticipated.

  • Variable interest rates. An increase in the annual interest rate will result in an increase in the cost of funding the self-funding instalments.

  • Extraordinary events and corporate actions may result in the completion date being brought forward.

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