Exchange Traded Notes and Index Linked Notes
In accordance with an ordinance from the Ministry of Finance, the process of converting the ETNs (Exchange Traded Notes) into ETFs (Exchange Traded Funds) will be executed in 11 stages. In Each stage a group of ETNs with similar characteristics will turn into ETFs. The first stage took place on October 4, 2018 and the last stage will take place towards the end of 2018.
Exchange Traded Notes (ETNs) are securities traded on the stock exchange issued by a financial institution (in Israel: ETN companies) and enable investors to track various underlying assets with a common denominator. For example, an ETN may track indices, currencies, commodities, and more.
The first ETN in Israel was issued in 2000. Today, the industry manages tens of billions of shekels in a wide range of certificates that track various indices and assets, and it is possible to purchase ETNs on indices traded in Tel Aviv, as well as international indices.
In the course of 2018, ETNs in Israel will be subject to the Joint Investment Trust Law, and will thus become Exchange Traded Funds (ETFs).
Index Products Worldwide
There are two main index products in the world: Exchange Traded Notes (ETNs) and Exchange Traded Funds (ETFs) - mutual funds that track a particular index.
The world's first ETF was launched in 1993 by AMEX, the pioneer in the field, under the name "Spider", and it tracks the S&P 500 index. Later launches include the Diamond, which tracks the Dow Jones Index, and NASDAQ'S QQQ, the world's most heavily traded security, which tracks the Nasdaq 100.
The index products industry is growing rapidly and is constantly offering new products to local and international investors. ETFs that track international indices can also be purchased on The Tel Aviv Stock Exchange.
ETFs on the TASE
Several types of index products are traded on the TASE:
- Index Certificates
- Commodity ETNs
- Reverse certificates
- Certificates of Deposit
- Covered warrants
- Complex ETNsand balance certificates.
A company that wishes to issue ETFs must comply with special registration rules that set minimum requirements for equity, insurance and rating. In addition, in order for the index to serve as a base asset for ETFs, it must also comply with a list of terms set by the TASE.
Exchange Traded Notes (ETNs)
ETNs are financial instruments that track stock, bond and other indices, and are issued by companies that focus on this area.
ETNs allow investors to indirectly hold all the shares or securities included in the index, according to their exact weight. Instead of the investor purchasing the securities directly, the certificate manager does so on his behalf. It is possible to convert the certificate into physical shares or, alternatively, to receive their monetary value.
Reverse certificates are a financial instrument whose performance is "opposite" to the underlying security index. In other words, if in a standard ETF, a decrease in the index it tracks reduces the value of the certificate as well - in a reverse certificate, a decrease in the index actually increases the value of the certificate. This allows reverse certificates to earn when the index falls, but they also lose when the index rises.
Reverse certificates can serve as a substitute for short selling, as not every investor is equipped with the appropriate tools for this type of trading. Reverse certificates on the TA-35 index, for example, can be a convenient substitute for the short selling of the shares included in the index.
In these certificates, the investor also receives interest based on the amount invested by the certificate issuer in a bank deposit.
Example - Reverse Certificate on the TA-35 Index
- A certificate was issued with an exercise price of 1000
- When the index reaches 800, the value of the certificate will be 200 - so leverage will be 4 and therefore early forced redemption will be made
Following 1 year
On Listing Date
Case 2 – Index decrease
Case 1 – Index increase
TA-35 Index (in points)
Reverse Certificate Price
A covered warrant is another type of ETF. The options give investors the right to "buy" (call) or "sell" (put) the underlying asset in the future at a fixed price, as detailed in the issuance prospectus. The options are suitable for institutional and private investors and allow them to be exposed to a certain index without purchasing the underlying asset - while paying only the premium. The options also serve to hedge risks. They protect investment portfolios against price declines, because they yield profit during such declines, and through covered warrants, sophisticated investment strategies can be built.
Under the TASE listing requirements, covered warrant may be issued on international indices (such as the S&P 500, Nasdaq-100, Dow Jones, etc.) on commodities and currencies.
The company issuing the covered warrants is their creator (writer), while private investors are buyers. Investors cannot write options (unlike MAOF options issued by the TASE), and therefore are not required to deposit collateral, since their loss is limited to the premium (the stock price) paid for the option.
Certificates of Deposit
The underlying asset of this type of ETF is a particular currency. The certificate tracks the rates of the same currency and bears interest, according to the conditions appearing in the issuance prospectus of the certificate. On the TASE, currency certificates which track the Shekel, the Dollar, the Euro and the Pound Sterling, among others, are traded.
There are several types of complex certificates:
A certificate tracking multiple indices
The weight of each index is predetermined in the issuance prospectus and it is not possible to deviate or adjust the composition of the weights determined.
Certificates tracking formulae based on given index
Many such certificates are traded in Europe, and in some markets they are called Accelerated Tracker. The certificates give double exposure to the index they track.
Example: An investor buys a certificate for NIS 100. The issuer borrows another NIS 100 and buys the underlying asset in the value of NIS 200. Upon conversion, the investor is entitled to receive double the index’s return during the relevant period of time minus interest that the issuer paid for the loan.
The exposure to the index is doubled, and the risk is greater than that entailed in a regular index-linked note. If the index rises, the investor wins double returns. But if the market falls, the loss is doubled.
Index-linked notes tracking variable indices
The prospectus must state up to 10 possible indices. The issuer can change the index that the certificate tracks up to four times a year, with 7 days’ advance notice.
The list of potential indices must be stated in advance in the prospectus. No other indices may be added later on.
During the advance notice term, the issuer shall not charge conversion fees. If a holder wishes to sell the certificate consequent to the change, it can be done at a low cost.
Long balance certificate and short balance certificate
A balance certificate is a leveraged certificate. Under the terms of the certificate, fixed times are set in which the issuer will execute the purchase and / or sale of securities in order to maintain the leverage determined in the terms of the certificate.
Example: In a long balance certificate whose underlying asset is the TA-35 index, the maximum leverage will not exceed three, and in a short balance certificate whose underlying asset is the TA-35 index, the maximum leverage will not exceed double.
Index Product Issuers in Israel – Websites