Down deep, somewhere in the boilerplate in the back of a prospectus for an index-linked note, you can find the provisions for index adjustments and successor indices. These standard provisions are sometimes given only a cursory glance when drafting a disclosure document. Index changes or discontinuances are rare, and even more rarely occupy much real estate in the mind of the draftsperson. There may be a rude awakening in store, however, for that inattentive draftsperson if the note is listed on the NYSE Arca.
Index Changes and Substitutions
What happens if the index sponsor makes a material change to the underlying index, or if the underlying index is no longer published and has to be replaced? In the event of a material change to the index that, in the opinion of the note calculation agent, causes the underlying index to no longer fairly represent the level that the index would have had if that change had not been made, most structured notes provide that the note calculation agent will make adjustments, in its discretion, to determine the level of the index. These adjustments are intended to adjust the closing level of the revised index as if the modifications to the index had not been made.
If the index sponsor ceases to publish the index, and the index publisher – or a separate entity – publishes a substitute index that, in the discretion of the note calculation agent, is comparable to the original index, then most notes provide that the new successor index will be substituted for the original index.
NYSE Arca Rules
All is well, unless the structured note is a listed “Structured Product,” as that term is defined in NYSE Arca Equity Rule 5.1(b)(17), or a listed “Derivative Securities Product,” as that term is defined in NYSE Arca Equity Rule 5.2(j)(3), Commentary .01(a)(A)(1). As examples, an exchange traded note linked to an index of equity securities and listed under NYSE Arca Equity Rule 5.2(j)(6) would be a Structured Product, and an Investment Company Unit listed under NYSE Arca Equity Rule 5.2(j)(3) would be a Derivative Securities Product. Issuers of structured products that fall into either of those two categories should consider NYSE Arca Equity Rule 5.3(i)(1)(i)(P), and consult with the NYSE if they are informed by the index sponsor of a potential future change to the index.
NYSE Arca Equity Rule 5.3(i)(1)(i)(P) requires a minimum 10-business-day advance notice (which may be made by telephone or email) to the exchange by the issuer if any of the following “Material Index or Portfolio Changes” to an underlying index or portfolio of securities are scheduled to occur:
- the value of the index or portfolio is no longer calculated or available and a new index or portfolio is substituted;
- the index or portfolio is replaced with a new index or portfolio from the same or a different index provider; or
- the index or portfolio is significantly modified (including, but not limited to, a significant modification to the index methodology, a change in the index provider or a change in control of the index provider).
A prospective change that constitutes a Material Index or Portfolio Change likely would require the issuer to submit to the NYSE a supplemental listing application, as well as a certified copy of the board resolution authorizing the change; such a change may also require the issuer to make a public announcement of the change by means of a press release, as provided by NYSE Arca Equity Rule 5.3(i)(2)(viii) (Immediate Public Disclosure of Material Information). If the prospective Material Index or Portfolio Change would cause the underlying index to no longer meet the NYSE Arca’s generic listing standards, which are set forth in NYSE Arca Equities Rule 5.2(j)(6), then, in order for the structured product to remain listed, a rule filing under Section 19(b)(2) of the Securities Exchange Act of 1934 would be required. Given that a 19(b)(2) filing is generally an extremely lengthy (and potentially expensive) process, if the prospective change is scheduled to take place prior to SEC approval of the 19(b)(2) filing, then the NYSE would direct that trading in the structured product be halted on the date of the change. If it becomes clear to the NYSE that the 19(b)(2) filing will not be approved or will not become effective, or the NYSE decides to withdraw the 19(b)(2) filing, then the NYSE will delist the note.1
Steps to Be Taken
Consequently, if the issuer of a listed Structured Product or Derivative Securities Product learns that an index sponsor or provider is contemplating a change to its methodology, it would be advantageous for that issuer to contact the NYSE Arca as early as possible to discuss the potential change, and to plan accordingly if the NYSE Arca would view the potential change as material.
Issuers of listed Structured Products may want to consider adding some extra language to the index adjustments and successor index disclosures in their prospectuses. For example, a typical exchange traded note is callable at any time from six months to one year after its initial issuance. An issuer could also include, either in a risk factor or in the index adjustment section, disclosure that any index adjustment or substitution could cause the note to be delisted. In that event, it is likely that the issuer would call the exchange traded note, and investors could be so informed in the prospectus.