Two Exchange-Traded Notes Become Unhinged

Exchange-traded notes (ETNs) are a new source of concern for investors, following the recent plunge of two ETNs. Barclays iPath DJ-UBS Natural Gas ETN has declined more than 50% in value since March 19. Meanwhile, an ETN sold by Credit Suisse Group AG – the VelocityShares Daily 2x VIX Short-Term ETN – saw about 60% of its value vanish during the past week.

As reported by Bloomberg, investors who bought the Credit Suisse ETN lost more than $253 million during its recent freefall.

Exchange-traded notes are some of Wall Street’s most complex products. ETNs issue unsecured securities that aim to deliver the return of an index. The issuer, usually a financial institution, uses derivatives linked to that index to cover obligations to shareholders. If the issuer is unable to repay the notes, investors lose their money.

Issuers also can decide to stop creating or redeeming shares, thereby unhinging the ETN from the security or index it was supposed to track.

“In short, an exchange-traded note can be seen as a total return swap, sold to retail investors, that lacks all of the regulatory innovations that have developed over the past few years,” said a March 29 article by the New York Times.

The Financial Industry Regulatory Authority (FINRA) is now investigating how firms market exchange-traded notes.