Barclays’ announced suspension, rescission of VIX ETN, oil ETN to have trading ramifications

By Emma Trincal

New York, March 29 – Monday’s announcement by Barclays that it sold over a registered capacity $15.2 billion worth of two ETNs was a shock due to the announced loss, which the bank estimated at £450 billion (or $592 billion) but not a total surprise. The issuer had disclosed two weeks before the suspension of sales and issuance of the two securities – the iPath Series B S&P 500 VIX Short-Term Futures ETN, listed under the ticker “VXX,” and the iPath Pure Beta Crude Oil ETN, also known as “OIL.”

“What it means is they’re suspending sales and not issuing new ones. If you own the ETNs you can always sell it to another person. You could probably sell it back to Barclays if it makes sense. But the bank cannot sell it back to someone else,” said an industry source.

Over-issuance

Barclays’ press release dispelled speculation about trading or hedging errors, ruling out market-related factors. Instead, the bank disclosed that it had exceeded the size of its U.S. shelf. In August 2019, Barclays registered $20.8 billion in maximum aggregate offering price but since then has exceeded the registered amount by approximately $15.2 billion.

The excess amount gives investors who purchased the ETNs over that period a right of rescission.

The bank did not specify who may be eligible for it but said the notes will be bought back at their “original purchase price.” The securities sold in excess of the registered amount have been offered and sold during a period of one year, according to the company’s release.

Barclays declined to provide further details about the rescission offer, which will be published “in due course.”

Things happen

The calculation of the estimated rescission loss for the bank was based on the pool of “eligible” purchasers electing to participate in the offer as well as on-the-market prices, the bank said.

Both ETNs are off their highs. But OIL has gained 87% over the past year while VXX has dropped 48%.

“It’s going nuclear in the world of ETNs. I can’t think of any rescission precedent before in the space,” said Steve Sosnick, chief strategist at Interactive Brokers.

Unlike ETFs, ETNs are direct liabilities on the bank’s balance sheet, he noted.

“You always have to cap your liabilities no matter who you are as a lender and especially with those esoteric exposures.

“Barclays should have halted issuance sooner.”

The announcement came as a surprise, said the industry source.

“They must have lost track. Barclays issues a lot of structured notes, not just ETNs. Let’s hope that’s it. We’ll know when we see the rescission statement,” he said.

The excess amount only affects the U.S. shelf. There is no reason to believe it will affect other shelves,” a person familiar with the matter said.

Sources did not speculate about the origin of the missteps.

“People screw up. Somebody forgot to check something. People make mistakes. Usually, the loss is on the issuer. They’re the ones taking the hit,” a market participant said.

Lucky few

The estimated loss also includes the cost of short-term hedging used by the bank to manage the risks arising from the rescission offer, according to the announcement. The release also noted that “the hedging impacts will reverse on conclusion of the rescission offer.”

“I heard of one case of a rescission before. It’s pretty rare. But usually, it’s also not a huge issue for the market because investors are taken care of. They’re protected by the law as they should be,” the market participant said.

He gave an example, specifying that he has no knowledge about the rescission offer.

“Your ETN was bought at 100 and is now trading at 120. Barclays will buy it back at market price, or 120. Nobody loses. The investor made money. The issuer made money too from its hedge. They both made 20%,” he said.

It’s when the market price falls below the issue price that the bank will incur a loss.

“Now the issue price is 100 and the ETN trades at 90. The bank has to buy it at the issue price. Good deal for the investor, not for the issuer. But that’s the way it should be. The issuer messed up. They have to pay for it.

“So, it’s actually good news for the people who purchased those ETNs.”

Decoupling

But the halted issuance of new ETNs is having a direct trading impact right now.

The limited supply tends to “decouple” the NAV from the market price, sources said. That in turn has direct trading implications for investors.

“When you suspend, the ETN has a life of its own. You can’t redeem. You can’t create. You can only trade between people. It’s very similar to the way a closed-end fund trades,” the market participant said.

But this has no bearing on the rescission process, he noted, since Barclays will repurchase the ETNs at their original price.

Sosnick also pointed to market distortions.

“I have no idea how Barclays will buy back the ETNs. Until I see the terms of the rescission offer, it’s impossible to speculate,” he said.

“But what I know is that in normal times, arbitrageurs prevent the divergences in prices between NAV and market price by creating or redeeming exchange-traded products, which keeps the prices in line.

“With the suspension, there is no mechanism that links the NAV of the VXX to the trading price.”

Supply and demand

And in fact, the VXX is trading at a “huge” premium, he noted.

Its closing price on Monday was $25.73 while its NAV was $20.03.

Such premium is reminiscent of what happened with now delisted Credit Suisse’s VelocityShares Daily 2x VIX Short-Term ETN, also known as “TVIX,” he said.

A year ago, Credit Suisse temporarily halted issuance of the TVIX ETN due to a short squeeze, he explained.

“The price surged, but then plunged once issuance resumed,” he said.

ETNs are much more vulnerable to such short-squeezes than ETFs because ETFs have no restrictions on the amount of new shares they can issue, he said.

“You rarely see the share price of actively-traded ETFs differ too much from NAV because there are always traders willing to arbitrage ETFs he said.

“But in the case of halted issuance for an ETN, the process is broken.

“If Barclays announced tomorrow that they’re reopening the ETNs, in theory the price would plunge because this premium would evaporate.”

Barclays in its announcement said it intends to file a new automatic shelf registration statement with the SEC “as soon as practicable.”

The bank did not specify whether the newly registered notes would carry the same ticker.

Short pain

Short-sellers of the VXX are particularly vulnerable, Sosnick added.

“Now the shorts are left hanging. Who is going to create the new shares? The only place to buy them back is in the market. They’re holding securities that are 25% overvalued. At the same time, you can’t short the shares to bring it to line. You have a dysfunctional market,” he said.

“These volatility-linked ETNs are really susceptible to blowups.”

How will the negative headline affect Barclays’ ETN and structured notes business? It’s anyone’s guess, he said.

“The most unforgiving mistake in trading is exceeding the risk limits whether by mistake or not,” he said.

“We don’t know the circumstances that caused them to issue above the shelf limit. But it’s going to raise a lot of questions about how it happened. I can imagine it will have ramifications internally. Whether it will affect the bank’s structured notes business, we don’t know. But it wouldn’t surprise me if portfolio managers, risk managers were reassessing their exposure to Barclays in light of this.”

The bank in its announcement said that it “remains committed to its structured products business in the United States.”

A spokesperson at Barclays declined to comment.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.