JJC - JJC: When ETN Structures Can Trip Your Portfolio

2023-04-20 14:56:58 ET

Summary

• JJC is an exchange-traded note set-up to track copper prices via the Bloomberg Copper Subindex.
• As an exchange-traded note, JJC is a Barclays bond, and the bank has announced the redemption of the structure in June 2023.
• Unlike the ETF or CEF structures, ETNs are actually just debentures and come with very specific additional structural risks.
• A retail investor looking to get exposure to the copper asset class needs to find a replacement financial instrument as well as deal with potential tax implications associated with the ETN redemption.

Thesis

In times of market stress many structural issues come to the fore, puzzling and sometimes generating substantial losses for retail investors. Not all financial instruments are created equal, and acronyms such as ETFs, ETNs and CEFs are not synonymous, each presenting a unique set of risk and rewards from a structural perspective. It is imperative for a retail investor in today's market to fully understand the nuances of complex products, such that they do not experience unpleasant loss-generating surprises down the line.

We have recently covered a number of ETNs from both UBS and Credit Suisse , and highlighted some ETN specific risks associated with the structures that at the first glance might be missed by a retail investor. No sooner that we wrote those pieces and Barclays announced they will retire an entire slew of ETNs:

NEW YORK--( BUSINESS WIRE )--Barclays Bank PLC ("Barclays") announced today that it will exercise its issuer call option and redeem in full each of the 21 series of iPath® ETNs (the "ETNs") listed in the table below on June 14, 2023 (the "Redemption Date").

As described in the prospectus for each series of ETNs listed above, Barclays, as issuer of the ETNs, may redeem the ETNs in its sole discretion on any business day on or after the inception date until maturity. Holders of such ETNs on the Redemption Date will receive a cash payment per ETN equal to the applicable closing indicative value or daily redemption value, as the case may be, of the ETNs (each as defined in the prospectus relating to the ETNs) on June 7, 2023 (the "Valuation Date"), the fifth trading day prior to the Redemption Date (subject to postponement in the event of a market disruption event). Trading of the ETNs will be suspended before the market open on June 8, 2023.

Holders of ETNs subject to issuer redemption may choose to continue to hold their ETNs until the Redemption Date or choose to sell/redeem their ETNs at a suitable time prior to that, subject to the paragraph below. Any redemption of ETNs is subject to the conditions and procedures described in the prospectus for the relevant series of ETNs and will be valued using the applicable closing indicative value or daily redemption value, as the case may be, on the valuation date for the transaction, in each case in accordance with the prospectus for the relevant series of ETNs. The procedures for redemption include delivering a notice of redemption and signed confirmation to Barclays prior to the relevant valuation date within the time frames set forth in the prospectus and instructing the DTC custodian at which the ETNs are held to book and settle a delivery vs. payment trade with respect to the ETNs.

There are a number of problems that pop-up for a retail investor who holds JJC (JJC), and we are going to discuss them in the below section.

Why is an ETN redemption a problem for a retail investor?

1. Tax Consequences

When an ETN redeems you are forced to take the capital gain or capital loss. Many investors plan ahead when significant gains or losses are recorded so that their tax implications are reduced or moved towards a level they want. JJC is down in the past year for example. If an investor is sitting on a capital loss for this name they will be forced to take it now, even if they do not want it or need it for their portfolio planning.

2. Loss of Underlying Risk Exposure

The most important aspect for an ETN redemption is the loss of the underlying exposure. JJC is set-up to track copper prices via the Bloomberg Copper Subindex , and it represents a commodity play. Once it gets redeemed a retail investor needs to find an alternative if he/she want to continue to have exposure to the sector. The issue lies with many investors who are not necessarily active investors, and they might find out months after the event that their copper exposure was cut mid through a financial year.

3. Lack of Market Alternatives

Sometimes the niche market covered by an ETN does not have any other readily available substitutes. As retail investors we are put in a corner because there are not many options out there. Institutional investors can always access markets via derivatives by going to a bank and asking for a customized swap to obtain a certain return profile. Luckily, for copper there is an alternative out there, namely the United States Copper Index Fund ( CPER ) which can be used as a substitute.

Why did Barclays do this?

As described in the article, ETNs are bonds. And when a bank issues bonds it needs to register them with the respective jurisdictional supervisory bodies. More than a year ago Barclays disclosed it had erroneously sold $15 billion more structured notes and ETNs over the course of about a year than it had registered for. At the time, the bank was forced to suspended any further issuance as it worked to resolve the issue. Subsequently the institution was fined regarding the matter.

Conclusion

The iPath Series B Bloomberg Copper Subindex Total Return ETN is an exchange traded note. The bond is issued by Barclays and is now set for redemption on June 7, 2023. As we have seen with the Credit Suisse and UBS ETNs, the exchange traded note structure has very specific additional risks that ETFs or CEFs do not exhibit. An investor who is a holder of JJC will have tax implications from the JJC redemption via the crystallization of capital gains or losses, and will need to find a replacement investment if they want to continue to hold copper exposure. One of the alternatives in the space is the United States Copper Index Fund. It appears Barclays undertook this radical action with respect to its suite of ETNs as a result of its own blunder more than a year ago, which resulted in notes being issued without the proper registration. JJC holders are now paying the price for Barclays' own mistakes in our view.

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