How ETNs Provide Issuers with Funding and Expose Investors to Credit Risk
Summary
The document describes exchange-traded notes as unsecured debt issued by a financial institution. Buying an ETN amounts to lending money to its issuer in return for index-linked exposure, generally reduced by fees. Investors therefore bear issuer credit risk: a default can affect repayment regardless of the performance of the referenced index.
One answer frames ETN proceeds as potentially inexpensive funding, with issuer fees providing revenue; another offers a hypothetical structure in which a bank uses a swap to obtain equity exposure and sells notes to investors for cash. These explanations are conditional rather than a universal account of bank financing. Whether ETN funding is cheap depends on borrowing costs, swap pricing, product expenses, and the issuer’s credit. The document does not establish that all ETNs use swaps or that they are necessarily cheaper funding than other sources.
Key ideas
- An ETN is unsecured debt, so investors are exposed to the issuer’s creditworthiness.
- Note proceeds provide cash to the issuer, while investors receive index-linked returns subject to fees and note terms.
- A swap-based structure could let an issuer package index exposure and obtain funding through ETN sales.
- Whether this funding is cheap depends on market rates, product costs, and issuer circumstances.
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Full text
# ETNs as bank funding # ETNs as bank funding I've just read the article in the link below and would like to know if someone can elaborate on a statement. I have added the whole paragraph, but highlighted the part about the use of ETNs as cheap funding. How does banks use ETNs as funding? I live in Denmark where the only ETF-like offerings are ETNs and I'm trying to figure out why none of the banks are creating ETFs. > The investment banks take advantage of their superior sophistication. From the get-go, the ETN is a fantastic deal for banks. It's in the DNA of the product; once held, an ETN almost can't help but be fabulously profitable to its issuer. Why? They're dirt-cheap to run because the fixed costs are already borne by infrastructure set up for structured products desks. They're an extremely cheap source of funding, the life blood of the modern bank. More important, this funding becomes more valuable the bleaker an investment bank's health. As a cherry on top, investors pay hefty fees for the privilege of offering this benefit. This isn't enough for some issuers. They've inserted egregious features in the terms of many ETNs. The worst we've identified so far is a fee calculation that secretly shifts even more risk to the investor, earning banks fatter margins when their ETNs suddenly drop in value. The article is from Morningstar: Exchange-Traded notes are worse than you think ## Answer by pyCthon (score 2, accepted) https://quant.stackexchange.com/a/17297 ETNs are senior, unsecured and unsubordinated debt securities issued by an underwriter. When you buy an ETN you are essentially lending money to the issuer in exchange for exposure to an index minus some basis points(management fees). As with most debt instruments, if the issuer defaults, you already assumed the credit risk. As for the question of why ETNs are a source of cheap funding (I'm skeptical on the life blood part), take into consideration that the largest ETN (AMJ) currently has 5.6 Billion in AUM and charges 0.85%. Some ETNs also accrue the expense ratio on a daily basis, UBS is known to do that. Consider the following example: UBS currently has 37 ETNs with a total AUM of 5.76 Billion. Assuming an average fee of 1.00% AUM, accrued on a daily basis, that would provide UBS with roughly $200k per trading day assuming a 252 day trading calendar. ## Answer by fgh (score 2) https://quant.stackexchange.com/a/79409 This is a hypothetical answer to your source of cheap funding question. Assume that swap rates are lower than the market yield on a bond the bank could issue to the market. They might instead enter into a pay fixed rate, receive equity return (on particular index) swap. The bank would turn around and sell the equity exposure to investors vis ETNs ultimately receiving cash for a "cheap" source of funding (in this example cheaper than prevailing market rates on debt funding)
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.