Exchange-Traded Notes Hold Unpleasant Surprises, Warns FINRA
Due to the exchange-traded note market’s recent problems with price
variations and issuer credit risk, the Financial Industry Regulatory Authority
(FINRA) has released a new investor alert warning investors to pay close
attention to the products’ associated risks before they invest.
Exchange-traded notes (ETNs) are basically unsecured debt obligations of
an issuer (typically either a bank or other financial institution) that
trade on exchanges and promise a return linked to a market index or other
benchmark. Though the name brings up the image of an ETF (exchange-traded
fund), ETNs do not buy or hold assets in order to replicate or approximate
the performance of the underlying index. They also, unlike typical bonds,
do not pay interest payments to investors. Instead, the issuer agrees
to pay the investor a “distribution,” based on the performance
of the underlying index or benchmark on the ETN’s maturity date,
minus specific fees.
The underlying index may be a familiar, broad-based index or it may be
a newer, more complex, or proprietary index. Additionally, the maturation
date may be decades into the future. These variations make the products
difficult for even sophisticated investors to understand, a reality FINRA
is afraid investors don’t fully comprehend.
"ETNs are complex products and can carry a raft of risks. Investors
considering ETNs should only invest if they are confident the ETN can
help them meet their investment objectives and they fully understand and
are comfortable with the risks," said Gerri Walsh, FINRA's Vice
President for Investor Education.
Risks associated with the products, include:
• Credit Risk;
• Market Risk;
• Liquidity Risk;
• Price-Tracking Risk;
• Holding-Period Risk;
• Call, Early Redemption, and Acceleration Risk; and
• Conflicts of Interest.
To learn more about the specific risks associated with exchange-traded
notes, read the full FINRA investor alert