The demise of an exchange-traded note is often accompanied by accusations, investigations and heavy losses. Rarely, if ever, has it involved the year’s best-performing product and assets well north of $1 billion.
The shock decision by Credit Suisse Group AG to drastically slash its ETN business, delisting nine securities worth nearly $3 billion, is the most powerful display yet of the existential crisis engulfing this corner of America’s $4.4 trillion market for exchange-traded products.
The move -- which the Swiss bank says is to better align its products with growth plans -- comes as coronavirus-fueled turmoil throws a harsh new light on ETNs. They frequently use derivatives to amplify returns, making them vulnerable to extreme market events. Already this year issuers including UBS Group AG and Citigroup Inc. have liquidated products.
The scale of the Credit Suisse move has sent a shock wave through the industry, however. Unless investors redeploy their cash into similar notes, the $10.8 billion ETN market is about to shrink by more than a quarter.
“That would not seem to portend especially well for them being a central part of the industry going forward,” said Jeffrey Ptak, global director of manager research for Morningstar Inc.
The highest-profile loss will be the VelocityShares Daily 2x VIX Short-Term ETN (TVIX), one of the most-popular notes for betting on volatility in U.S. stocks. At the time of this week’s announcement, it boasted $1.5 billion of assets and year-to-date returns of more than 200% -- the best performance among almost 2,400 ETPs in the U.S.
A spokeswoman for Credit Suisse declined to comment further on the reasons for the delistings, and it remains to be seen how the disappearance of products such as TVIX will impact the assets they track.
But for the ETN ecosystem it’s the latest dramatic twist in a year of reckoning, with analysts increasingly questioning the viability of such products even as the ETF industry continues its astronomical growth.
Unlike ETFs, ETNs are unsecured debt obligations issued by banks that are backed by the issuer rather than the assets the product is linked to. They’ll often be used as a way to get leveraged exposure to asset classes that may not fit into the confines of a traditional fund -- a practice coming under increased scrutiny from regulators.
“ETNs are quintessentially niche and, at this point, are not the first name in reliability,” said Ptak.
The notes earned a black eye after a massive spike in expected stock volatility blew up multiple products in February 2018, with a feedback loop emerging that saw ETNs exacerbate the damage.
Well before that, TVIX was no stranger to controversy. At one point in 2012, the VIX-linked note plunged by 50% in two days. Credit Suisse had frozen new share creation citing internal limits on the size of the product, and when it started issuing shares again the price of the ETN crashed.
The bank’s decision to finally pull the plug is a warning sign about the ETN space as a whole, according to Todd Rosenbluth at CFRA Research.
“That certainly sends a signal to investors that perhaps these products don’t have the viability,” said Rosenbluth, CFRA’s head of ETF and mutual fund research. “The delisting risk is something people tend not to pay attention to, and they really should.”