Barclays pegs ETF Plus coupon to gains from lending securities; structure is unusual, observers say

By Kenneth Lim

Boston, June 26 - Barclays Bank plc on Thursday launched an unusual series of ETF Plus fund-linked notes that pays a variable coupon based on the intrinsic rate of lending the underlying shares.

Barclays note has floating rate

Barclays plans to price the ETF Plus notes linked to the iShares MSCI Emerging Markets index fund. The maturity date has not been set.

The payout at maturity will be par plus the fund return.

The notes will also bear monthly interest equal to the average daily intrinsic rate of the underlying ETF minus the greater of 50 basis points and 30% of the intrinsic rate.

The intrinsic rate is the spread between the applicable benchmark overnight rate and the rebate rate that would be paid to a borrower of the ETF.

The underlying ETF aims to track the price and yield of the MSCI Emerging Markets index.

Coupon raises eyebrows

The unusual coupon structure was news to at least one investment advisor.

"I haven't seen anything like this before," the advisor said. "I'm afraid I don't know too much about this."

In the product prospectus, Barclays said the structure allows individual investors to enjoy the benefits of lending ETFs.

The borrow rebate is usually lower than the overnight rate, so the intrinsic rate generally represents the profit to the lender. But the lenders are typically institutions, and individual investors are rarely on the lending end of the equation.

"According to the International Securities Lending Association, the balance of securities on loan for the year 2007 exceeded US$2 trillion globally," Barclays said in the prospectus. "Securities lending of ETFs is becoming an increasingly important share of that market. Barclays ETF Plus notes now offer the benefits of securities lending to ETF investors that institutions have been enjoying for years. In addition to the price and yield returns of the underlying ETF, Barclays ETF Plus notes pay the holder a variable coupon linked to revenues available from lending the ETF."

Past ETF Plus products have also paid a coupon in addition to the final redemption amount of the notes, but the coupons have usually been pegged to the dividends paid to the underlying fund shares.

For example, an ETF Plus note linked to the same iShares MSCI Emerging Markets index due Sept. 8, 2008, will pay a coupon of 2% plus the apportioned dividends at maturity in addition to the redemption amount of the notes. The redemption amount for that series is par plus the underlying share performance.

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