Exchange Traded Notes (ETNs) Bring R2,6 billion in Issued Share Capital to the JSE

Listings Boom in Exchange Traded Notes (ETNs)

There are now 14 Exchange Traded Notes (ETNs) listed on the JSE, making this by far the most active sector of the JSE Main Board in terms of listing activity, to date in 2011. These ETNs, through the issue of tranches of their authorised share capital, have raised some R2650 million in new capital, so far this year.

ETNs are listed securities that provide access to the performance of an underlying asset, typically an index or a commodity in the South African experience. The issuer of the ETN has the obligation: to provide the full performance of the underlying assets; to provide market making services to ensure constant liquidity at fair value; and the open-ended nature of ETNs enables new securities to be created or redeemed to meet market demand.

The investor in ETNs has to acknowledge the counterparty risk and the creditworthiness of the issuer of the Exchange Traded Note.

ETNs are providing the local investor with a number of exciting investment opportunities, in many asset classes currently not available elsewhere in the South African market. These include the three new Deutsche Bank ETNs, which now give exposure to China, an index of 23 Emerging Country stockmarkets and an index of the major Africa stockmarkets. Commodity ETNs, offered by Standard Bank, give direct investment in global commodity markets, including gold, platinum, palladium, silver, corn, wheat, copper and oil. Very recently a commodity basket ETN has been launched by Standard Bank, which gives a weighted exposure to most of these commodities, including aluminium. RMB has also listed an Oil ETN, as well as a Coal ETN, which is apparently the only direct exposure to coal through ETNs anywhere in the world.

Exchange Traded Funds (ETFS)

Only 3 new ETFs have been listed to date in 2011 – the two NewFunds MAPPS balanced fund ETFs and the Proptrax Ten ETF. However, many existing ETFs have continued to issue additional securities, or to redeem securities, as and when market conditions require such action.

The ETF Management Companies that have issued net new capital are: Satrix Managers, which has raised an additional R532 million in capital; Stanlib R368 million; Deutsche Bank R144 million and BIPS (RMB) R210 million. However, this has been more than offset by a redemption in issued securities of NewGold, accounting for a capital reduction of R1710 million. Whilst NewGold has provided top performance for investors this year, due to the inexorable rise in the US Dollar gold price, plus the recent rand weakness, there appears to be some profit taking by large investors, requiring Absa Capital, the issuer of the NewGold ETF, to sell some of its physical holdings of gold and to reduce the number of NewGold securities in issue.

The aggregate effect has been a net outflow of R517 million in total capital from ETFs.

Liquidity in Exchange Traded Products (ETPs)

Nearly all transactions in ETFs and ETNs occur in the secondary market, i.e. on the JSE during daily trading. Access to the primary market, i.e. the Management Companies (the MANCOs) of the Exchange Traded Products (ETPs), is only required when the secondary market is unable to accommodate daily transactions.

Primary market transactions occur:

• When there is a lack of, or excess of, liquidity on the JSE requiring that additional securities be created or redeemed by the MANCO.

• When the market maker builds up a large position and approaches the primary issuer of the ETF/ETN to offset such inventory.

• When a large investor, typically an institution, wishes to move significant amounts of money into or out of an ETF/ETN, the MANCO can create or redeem securities for this purpose. This is a particular benefit of ETFs/ETNs as virtually any size transaction can be accommodated through the primary market without impacting on secondary market trading or liquidity.

• When a new listing of an ETP occurs, the issuer can raise capital from investors, through an IPO or private placement and then create new securities with this capital.

Any of these transactions in the primary market for ETPs would lead to the inflow or outflow of capital from the Exchange Traded Funds and Notes sectors of the JSE.

As detailed in the Table (overleaf), this has led to a net inflow of R2133 million capital into Exchange Traded Products in the first seven months of 2001. Given difficult market conditions, this is an encouraging performance.