While the exchange traded product universe is comprised of exchange traded funds and exchange traded notes, ETNs are slowly being pushed to the side with ETFs taking center stage.
About 61 ETNs, or a third of the U.S. ETN market, continue to trade despite obstacles to the creation of new shares, and others have been delisted from major exchanges, the Wall Street Journal reports.
Similar to index-based ETFs, ETNs also track some sort of index as part of their investment strategy. However, an exchange traded note, like the name implies, is a type of debt note that trades on an exchange.
ETNs are debt securities issued by financial institutions that promise to pay the return of an index, minus fees and taxes. Therefore, investors are exposed to the credit risk or the possibility the underwriting bank goes bankrupt. The note can be vulnerable if the issuer gets into financial trouble, otherwise known as a default. With an ETN, an investor can lose some or all of their investment if the ETN issuer goes under.
Banks are now shying away from the ETN business as regulatory pressures forced many to set aside more capital to cover potential losses. Consequently, as ETNs grow in size, banks would have to set aside more capital to safeguard against a default, which may not be the most profitable use of their shrinking balance sheets.
However, banks can’t force investors to liquidate their ETNs, and ETNs can’t be closed until they mature – typically between 20 to 30 years after they are issued. Consequently, some are opting to delist the ETNs from major exchanges and allowing the notes to trade in gray markets, such as what Credit Suisse AG, the underwriting bank, did for the VelocityShares 3x Long Crude ETN (NYSEArca: UWTI) and VelocityShares 3x Inverse Crude (NYSEArca: DWTI).
The underwriting banks may also suspend issues of new shares, which would cause the ETNs to act more like closed-end funds and trade at huge premiums or discounts to their net asset value. For example, the iPath Crude Oil Futures ETN (NYSEArca: OIL) traded with a premium of as high as 48% in January after the issuer suspended creations.
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