SEC may target exchange-traded notes next in push to simplify

A regulatory push to make complex securities easier to understand could change how banks disclose risks for exchange-traded notes for the first time since they began trading in 2006.

Lenders may not be adequately explaining to investors how they value ETNs, Amy Starr, head of the Securities and Exchange Commission’s capital markets trends office in Washington, said at an industry conference last week. ETNs, which combine bank debt and derivatives, trade on exchanges and are tied to assets from gold and stocks to volatility indexes.

ETNs have surged this year, with holdings increasing by 37% to $22.1 billion, according to data compiled by Bloomberg. Disclosures for the securities in offering documents should become simpler as the indexes they link to become more complex, said Colbrin Wright, assistant professor at Brigham Young University in Provo, Utah.

“When you’re talking about disclosure regulation, you have to be thinking about the unsophisticated investor,” he said in a telephone interview. “It’s simply a matter of making sure that investors go in with their eyes wide open.”

In April 2012, Starr’s office asked banks that sell structured notes to boost their disclosures to investors, including their own estimates for the securities’ market value at the time of sale. The figures, which are now included near the front of U.S. prospectuses, show that issuers value most notes between 96 and 98 cents on the dollar, Bloomberg data show.

Finra Warning

The SEC hasn’t formally made any requests for similar disclosure-related changes for ETNs. Florence Harmon, a spokeswoman for the agency, declined to comment on Starr’s remarks and on whether the SEC will issue guidelines for the exchange-traded products.

The Financial Industry Regulatory Authority warned investors in a July 2012 letter that an ETN’s indicative price, which is calculated by the issuer, could differ “sometimes significantly” from the market value.

The notice came after Credit Suisse Group AG stopped issuing shares of an ETN tied to the Chicago Board Options Exchange Volatility Index, or VIX. That note, which trades under the ticker TVIX, later traded at a premium of as much as 89 percent before losing more than 50 percent of its value over two days in March 2012.

Barclays Plc was the first bank to offer ETNs in the U.S. in June 2006. The next month, the SEC issued a ‘no-action’ letter, saying the commission “will not recommend enforcement action” on the securities, clearing the way for the notes to trade freely.

The first two ETNs tracked benchmark commodity indexes. Now there are more than 200 of the securities in the U.S., linked to everything from the total return version of the Barclays Capital Global Carbon Index to “trend” strategies that switch between following groups of stocks and yields on U.S. Treasury bills.

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