1. What is a certificate ?
Certificate are securities which incorporate options-based investment strategies, tradable on regulated markets. Thus, certificates are securitised derivatives, usually listed on specific markets, which allow indirect investments on other financial assets (so-called “underlying assets”). Certificates may be characterized by the presence of financial leverage and feature a speculative risk/return profile (Leverage Certificates), or fit investment strategies for the long run (Investment Certificates).
2. What are derivatives ?
In finance, the word “derivative” indicates financial instruments whose value depends on the market value of another asset (which is referred to as “underlying asset”), which may be either a financial asset, like stocks, indexes, interest rates, or a real asset, such as a commodity.
3. What are securitised derivatives ?
By securitised derivative we mean a derivative which is integrated in a tradable security. Securitised derivatives are not contracts, unlike other derivatives like futures and options, but securities issued by a financial institution. There are two categories of securitised derivatives: certificates and covered warrants.
4. What is the underlying asset of a certificate ?
The underlying asset is the financial or real asset the value of the certificate depends on. It may be a stock index, a basket of commodities, an interest rate, and so on. The underlying asset may consist in a single asset or in multiple assets.
5. What are the consequences of the issuer of the underlying asset’s default on the subjects who have invested in certificates ?
To understand the effects of a default of the issuer of the underlying asset, we must first understand what a default consists in:
- If the company is temporarily unable to pay some of its debt, for example coupons or the face value of a bonds issue, there are no consequences on the holders of certificates.
- If the change in the issuer’s credit rating affects share price, the value of the certificate will also be affected.
- If the default of the issuer causes the share price to drop to zero, then the primary parameter the value of the certificate is based on will disappear, there will be an early expiration of the certificate and the certificate’s holder will receive a settlement consistent with the fair market value.
Certificates holders have no claims on the issuer of the underlying asset’s equity, nor can they be considered creditors of the company. As a matter of fact, even though the value of certificates depends on the behaviour of underlying asset’s price, certificates holders must be considered creditors solely of the issuers of such certificates. For a better understanding of such topic, however, one should always refer to the specific rules contained in the prospectus of each product category.
6. What if the underlying asset becomes illiquid?
In case a certificate’s underlying asset does not maintain the liquidity requirements of its market, or in case such asset is suspended from trading and does not get listed again, the certificate is usually subject to early expiration and the certificate’s holder receives a settlement consistent with the fair market value. For more detailed information on such topic, however, it is necessary to refer to the rules contained in each certificate’s prospectus.
7. Is it possible for the issuer to change a certificate’s characteristics during its life ?
Yes, the issuer of a certificate is legally allowed to change some of the features of its products to keep the investors’ positions neutral in case extraordinary events involving the underlying asset take place. For example, if the issuer of the underlying asset proceeds to a merger with another company to create a new venture, the certificate’s issuer will replace the original underlying asset with a new one (that is, shares of the old company will be replaced by shares of the new one). For more detailed information on such topic, however, it is necessary to refer to the rules contained in each certificate’s prospectus.
8. What do we mean by fair market value of a certificate ?
A certificate’s fair market value is the value of the instrument as computed according to the issuer’s fair valuation standards and best practice, based on the most recent available market prices and all useful information about the underlying asset. If the certificate issuer proceeds to the liquidation of the fair market value, it must provide all information used in the definition of such fair price.
9. What are the consequences of the default of the issuer of the certificate ?
In case of default of the certificate’s issuer, the certificate holder is in the same conditions of the other unsecured creditors of the issuer.
10. When does a certificate belong to the quantum category ?
A certificate is called Quantum when the underlying asset is issued in a currency different from the Euro but the certificate’s issuer conventionally sets an exchange rate 1:1 between the Euro and the foreign currency and denominates the underlying asset in Euro. For example, the S&P 500 index is denominated in USD, but, if it is used as underlying asset for a Quantum certificate, its value will be expressed in EUR: let the index value be 826 index points, such index points will be in EUR – and not in USD. Thus, Quantum certificates allow investments in underlying assets whose denomination is not expressed in EUR, protecting the investor from the risk of unfavourable modifications in the exchange rate.
11. What is the difference between certificates and ETFs ?
Certificates and Exchange Traded Funds (ETFs) are both financial instruments that allow indirect investments in financial or real assets (“underlying assets”). However, unlike ETFs, certificates do not pay dividends; an ETFs issue is backed by independent assets that serve as a warranty for the investors in case of default of the issuer, whereas investors in certificates are exposed to the risk of a default of the issuer; ETFs do not have a maturity, while certificates usually do (at maturity, certificates expire and the investor receives a payment from the issuer); investments in certificates do not require additional management fees, while investments in ETFs do; certificates are subject to a taxation of 26% on capital gains, whereas ETFs are subject to different tax regimes depending on their characteristics: for example, the funds that conform to European regulation are subject to a taxation of 26%, while those that do not conform are subject to a different tax regime. In addition, it is possible to invest in “Benchmark Open Ends” which, just like ETFs, do not have a maturity.
12. Has the investor any obligation to hold the certificate till maturity ?
No: certificates are listed on regulated markets and can be sold anytime.
13. What is the difference between the issuer and the market maker ?
The issuer is the financial institution that issued the certificate and thus the subject the investor is creditor of (the credit amounts to the liquidation the issuer must pay at maturity). On the other hand, by market maker we mean a subject responsible for the liquidity of certain financial instruments, so that there will always be the chance for the investors to buy or sell such instruments on the market.
14. Do investors in certificates receive dividends if the underlying asset is a stock index ?
As for Benchmark certificates, there is no dividend payment as the present value of future dividends is implicitly discounted at the moment of purchase: the certificate’s price is lower than the actual index value. As for all other categories of certificates, dividends are not paid to the investor as they are used by the issuer of the certificate to fund the structuring process of the instrument (that is, for example, to buy the options needed for capital protection etc.).
15. Where can one find a certificate’s legal documentation ?
Every certificate’s prospectus can be read or downloaded through the product files available in this website, in the issuers’ websites, or on Borsa Italiana’s.