UBS' lowering of minimum redemption amount for E-Tracs seen positively

By Emma Trincal

New York, Jan. 7 - UBS AG's announcement on Wednesday that it reduced the minimum redemption amount for 11 of its exchange-traded access securities (E-Tracs) should increase market efficiency and benefit smaller players and arbitrageurs alike, sources said. The minimum amount was lowered to 50,000 notes from 100,000 notes, according to a company press release.

The E-Tracs track the performance of several commodities. The new measure is designed to facilitate redemptions of large block of notes directly with UBS, the sponsor.

"It's not something I have seen being done before in my observation," said a market participant who follows the exchange-traded notes and exchange-traded funds market for his clients. "But I think it's a positive for the market."

Two redemption courses

A sellsider explained that investors have two options to redeem their notes, depending on how much they own.

One - often the only choice for small investors - is through the exchange where the ETNs are listed. There is no redemption minimum, but investors have to deal with a bid and ask spread, he noted.

The second option, for investors who own at least the minimum required number of securities, is to sell their notes directly to the sponsor, in which case they can secure a pricing at net asset value.

When investors need to buy notes, the same two options exist and the process is called "creation."

"It's a behind-the-scene market," the market participant said, commenting on the "creation/redemption" mechanism that occurs over the counter. "The sponsor has the opportunity to create and redeem units of shares as needed based on supply and demand in the market, a little bit like a specialist would on the floor of an exchange."

More arbitrage opportunities

The sellsider noted that the new measure does not necessarily mean that investors will get a better price. "If you're a buyer and the shares trade at a discount to NAV, you're better off buying on the exchange rather than going through the creation process with the issuer," this sellsider said.

"But the measure will facilitate arbitrage," he added. "The reason why people want to use creation/redemption is because it introduces an arbitrage mechanism. It forces the price to trade at NAV all the time."

Many banks or even small registered investment advisers routinely use arbitrage techniques in order to make money for their clients or for their own books, the sellsider said, adding that they often use ETNs and ETFs to do this.

"Arbitrageurs, including in the specialized desks at banks, understand that they can make a profit when the market price diverges from the NAV," the sellsider said.

"Anytime I can sell at a premium and buy at a discount, I like it," said one of those arbitrageurs.

More efficiency

"It's a positive measure in my view. It adds to the efficiency of the market," said Richard Farkas, financial adviser at Strategic Global Investment Services in Campbell, Calif.

"Now a smaller institution, an independent money manager or a simple registered investment adviser can sell a block of shares and access the NAV pricing in a much [more] efficient manner," he said.

"Before the announcement, say your share trades at $25, you needed 100,000 shares, or $2.5 million, to go directly to UBS. Now you only need half of that," the sellsider said.

Law of supply and demand

The new measure may also lower large volatility swings and reduce the negative impact of large block sales on prices, the market participant said.

"It's a simple law of supply and demand. If somebody sells a large block in the market, it will push prices down. Now they can dump the shares back office to back office without disrupting the price," he said.

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