New Financial Instrument: "Kranot Sal" - ETF/ETN Hybrids Traded On Tel Aviv Stock Exchange

The Israel Securities Authority (ISA) in conjunction with the Tel Aviv Stock Exchange (TASE) are working to enable the listing of a new financial instrument on TASE. As the Hebrew name suggests, “Kranot Sal” (literally “basket funds”) constitute a hybrid between open-end mutual funds and exchange-traded notes (ETNs) referred to in Israel as "Teudot sal" (literally “basket certificates”). This new instrument is based on the American model of Exchange-traded Funds (ETFs), but has been adapted to Israel’s capital market by incorporating elements drawn from the local ETN market. The Kranot Sal ETFs will be structured as tracker funds, i.e. a fund whose express policy to track through replication a market index or other underlying asset. Unlike existing mutual funds, the new instrument will be traded on the Tel Aviv Stock Exchange and the process of creating and redeeming fund units will be incorporated in the trading process. The launch of this new type of security will expand the universe of publicly traded financial instruments and will render competition in the market more effective.

In March 2008, Prof. Zohar Goshen, Chairman of the ISA, with the aim of enabling the introduction of Israeli ETFs, lead an initiative to transfer the regulatory regime governing ETNs from one based solely on full disclosure to one based on substantive regulation, such as that governing the mutual fund industry. In August of that year, he and TASE Chairman, Shaul Bronfeld, appointed a committee to examine avenues to bring this about. It is estimated that the new Israeli ETFs will hit the market some time in the second half of 2010.


	Characteristics and Operation of ETF Trading
	The trading of ETF units will commence the day following their offering and will be traded in a manner similar to ETN trading. Existing open-end tracker mutual funds will be entitled to convert themselves into ETFs. ETFs which fail to attract a minimum threshold investment within a designated period of time will be delisted and converted into conventional mutual funds. The ETF issuer will serve as market-maker, providing liquidity for ETF units by quoting prices according to rules stipulated in the legislation. The ETF managers’ market activity will be translated into the creation and redemption of ETF units. Unit sales by ETF managers during trading will create new units, while the purchase of units from the public will culminate in cancellation of the units. The rules governing the market activities of ETF managers will be designed to ensure the interests of ETF unit-holders, including rights to revenues which may cause the ETF to out-perform the tracked asset. In order to ascertain transaction prices and facilitate timely coverage, ETF manager will be entitled to trade in ETF units only during the continuous trading phase (in which bilateral trade is conducted) and only on days on which the ETF’s net asset value can be calculated. In addition to market making activity, TASE will conduct ‘regular’ trading in EFT units, even on those days on which market-making is not allowed. In addition, unit-holders will be entitled to redeem their units directly from the ETF manager (as is the practice regarding Israeli ETNs), according to the ETF’s net asset value at time of redemption.

Preparations for ETF launch

In order to enable trading of mutual fund units on a securities exchange, amendments to the Joint Investment Trust Law-1994, TASE Regulations and the TASE Clearing House Bylaws will be implemented. In addition, TASE is working to set up the infrastructure necessary to accommodate ETF trading.

The creation of this market is part of a broader program initiated by the ISA and ETN managers to revise the regulatory regime governing ETNs to bring it closer to regulation currently placed on mutual funds.

The following comparative table summarizes the distinctions between the three types of market-tracking instruments that will be available after the launch of the new ETFs:

	ETNs *("Teudot sal")*	ETFs *(“Kranot Sal”)*	Tracker Mutual Fund
Arrangement	Note bearing an obligation to redeem according to the value of the tracked asset	Mutual fund designed to replicate a tracked asset	Mutual fund designed to replicate a tracked asset
TASE-traded and market making	Yes	Yes	No
Purchase & redemption	According to market prices. Investor option to redeem from issuer according to value of the liability at time of redemption	According to market prices. Investor option to redeem from manager according to net asset value of ETF	According to net asset value of the fund
Entitlement to surplus income from assets and trading	Issuer entitled to surpluses	Unit-holders entitled to surpluses	Unit-holders entitled to surpluses
Payment of distribution fees to issuer/ fund manager	None. Investors pay fees to TASE member	None. Investors pay fees to TASE member	None. Investors pay fees to TASE member
Market risk	Yes	Yes	Yes
Issuer risk	Yes	No	No
ISA regulation	Amended Joint Investment Trust Law	Amended Joint Investment Trust Law	Amended Joint Investment Trust Law