How do ETCs work?

Creation/redemption
ETCs are notes which provide the owner of the security with exposure to the actual underlying commodity future or spot price.

Exchange Traded Commodities are created through an authorised participant. The issuer then enters into a contract with the ‘commodity exposure provider’, the fulfilment of which results in the price of the security tracking the relevant commodity/ies.

This means the monthly roll, custodianship, and management are effectively ‘outsourced’ to the issuer and ‘commodity exposure provider’, in return for the annual management fee. However, because these are passive investments, the management fee is typically very low.

Creation

• a) The authorised participant (often the market maker) pays cash to the commodity exposure provider – the amount paid is based on the current creation price,set by the issuer.
  b) The commodity exposure provider then invests the money in the appropriate underlying
  commodity market/s.
• The commodity exposure provider notifies the issuer
  that cash has been received and confirms correct amount.
• The issuer asks CREST to create securities and transfer them into the account of the authorised participant. These securities are then available for the authorised participant to trade in the secondary market.

Redemption
Redemption is the process of creation in reverse. The authorised participant transfers securities to the issuer, who cancels them and notifies the commodity exposure provider to pay in cash the relevant amount to the authorised participant.

Collateralisation
ETCs that track DJ-AIG indices issued by ETF Securities are 100 per cent collateralised. This collateralisation means that the counterparty risk has effectively been removed. The collateral is held in a trust on behalf of the investors in a segregated account at the Bank of New York Mellon. The collateral in this account is managed on a daily mark to market basis by the Bank of New York Mellon. The collateral does not form part of the balance sheets of the Bank of New York Mellon or AIG.

For more information you can email etcs@londonstockexchange.com or speak to your broker.