Korea Capital Market Institute

ETNs are index tracking products that trade on an exchange. Unlike Exchange Traded Funds (ETF), ETNs are senior, unsubordinated, unsecured debt securities. Barclays introduced the first ETN to the New York Stock Exchange in 2006. Under the low interest rate environment, ETNs have attracted retail investors seeking high yield investments associated with commodities or emerging markets. While ETFs are subject to restrict regulation and suffer from tracking errors, ETNs are easily issued and don’t have tracking errors.

However investors lost confidence in the ETN market when three ETNs issued by Lehman Brothers got delisted in September 2008 due to the collapse of Lehman Brothers. As the global crisis recedes and interest rates remain low, the ETN market is resurrecting. The ETN market has expanded to Canada, Europe, Africa, and Asia. Benchmark indexes have diversified to include commodities, currencies, volatility, equity, fixed income, and MLP. In addition, leveraged or inverse ETNs have been introduced to the market. As the structure of ETNs gets complicated, investor protection issues such as issuer’s credit risk, diversified fee structures, the contango phenomenon, and abnormal price movements have emerged.

Especially, unexpected severe tracking errors might occur when issuers suspend issuance of new ETNs or contango happens. Therefore financial regulators have warned investors about risks associated with ETNs.

The introduction of ETNs to Korea’s capital market will be meaningful in a couple of ways. Firstly, ETNs can meet the needs of investors who are suffering from the lack of middle risk investments. Secondly, the introduction of ETNs can give Korean investment corporations, which heavily rely on brokerage fees, an opportunity to diversify profit sources.

There seems to be three ways to introduce ETNs to Korea. The first is to introduce ETNs listed on foreign stock exchanges such as NYSE via second listing or back-to-back swaps. In this case, it is important to choose benchmark indexes without overlapping those of current ETFs in KRX. The second is to create ETN markets for early redemption of securitized derivatives like ELS and DLS. The structures of ELS and DLS should be changed in order to simplify their pay-offs for this market. The last way is to develop Korean ETN products. And the KONEX ETN needs to be considered because it can contribute to the development of KONEX market.