The Securities and Exchange Commission is taking a closer look into exchange traded notes, highlighting the importance of understanding the note’s structure.
Earlier this month, the SEC sent banks a letter that asked to explain the fees they charge when issuing the notes, values of the securities and how they are marketed, reports Kevin Dugan for Bloomberg.
ETNs are not exchange traded funds, and investors should know the difference. The notes are a type of bank debt traded on exchanges like stocks, but they use derivatives to gain exposure to their target strategies. Consequently, investors are exposed to credit risk and could lose their principal if the issuing bank goes bust. [What Are ETNs?]
Regulators are seeking more detailed disclosures on both technical and broader aspects from the underwriting banks. For instance, there are questions concerning how the debentures trade relative to their net asset values, if notes with “shares” in their names could be misleading, and why some fees, such as those in hedging, are separate from others, like costs from indexing.
ETNs have been put under the microscope after the VelocityShares Daily 2X VIX Short-Term ETN (TVIX) began trading at a premium of as much as 89% to its net asset value before plunging over 50% over two days in March 2012. [TVIX Washout Raises Questions Over ETNs]
The Financial Industry Regulatory Authority has warned investors that an ETN’s indicative price could differ “sometimes significantly” from the market value.
Unlike ETF providers, ETN issuers can halt creations of new shares, essentially forcing the notes to act like closed-end funds, which can induce large premiums or discounts to the indicative value. [Why a Volatility-Linked ETN is Diverging from the VIX]
For more information on exchange traded notes, visit our ETNs category.
Max Chen contributed to this article.
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