We can’t wait to see how this turns out.
In London, a new class of “Collateralised Currency Securities” has hit the market. Basically, they’re ETF-like instruments that track specific currency pair trades. So, an investor could buy an asset specifically designed to go short USD/long EUR or one of several other permutations.
They sound complex, and given the history of so many ETFs and ETNs that have tried to track something complex, investors ought to be very warry.
FT Alphaville explains how they work:
Investors buy units of, for example, the long AUD Short USD ETC on the London Stock Exchange.
When enough units are purchased to raise the price of units relative to the NAV of the ETC — as implied on a constant basis by the relevant MSFX index (minus management, broker and transaction fees) — an authorised participant (AP) spots an arbitrage opportunity and offers to buy units at the NAV price direct from the issuer for cash, which he sells on for a risk-less profit to the market to ensure tracking.
Here though the AP does not deal with ETF Securities directly but via the ETCs’ chief counterparty, Morgan Stanley.
Morgan uses the proceeds it receives to hedge its total-return-swap exposure — but essentially can do whatever it pleases with the money.
To ensure that investors are protected in the event that Morgan Stanley fails to guarantee the performance of the index, Morgan Stanley pledges collateral to ETF Securities’ custodian — Bank of New York Mellon.
That collateral can be made up of any of the following: AA-rated G20 government bond, AAA-rated shares of government or treasury money market funds, AAA-rated supranational bonds, unsubordinated bonds issued by Ginnie Mae and any equity listed on “specified indices” anywhere in the world.
Bank of New York Mellon has the responsibility of monitoring the eligibility of the collateral, but to all extents and purposes, from what we can make out, Morgan Stanley determines the valuation on a daily mark-to-market basis.
Of course, if you were interested in what these actually consisted of, you’d be disappointed because there doesn’t appear to be any public record offered. All we know is that equities have to represent an over-collateralisation of between 105-110 per cent — i.e. be worth more than the underlying obligation by that percentage — and bonds between 100-102 per cent. If the collateral falls below those parameters Morgan Stanley is obliged to deliver the difference via a master repo agreement.
Meanwhile, we understand that Morgan Stanley’s position as chief counterparty does not make it ineligible for the role of authorised participant. In fact, from what Bienkowski tells us, the bank is currently listed among the ETCs’ APs. Read the whole thing >
If you’re curious and have an afternoon to kill, here’s the prospectus: