Due to internal company limits on the number of exchange traded notes it can have circulating in securities market, Credit Suisse said Wednesday it has temporarily suspended issuance of the high volatility product VelocityShares Daily 2x VIX Short-Term ETNs.
According to one expert on exchange-traded funds, Morningstar analyst Timothy Strauts, the decision is tied to Credit Suisse’s concerns over hedging tied to such an extremely volatile, highly leveraged product.
“This is, on a daily basis, one of the most volatile products available in the market today—with sometimes 10-20% movement in a single day,” he said. “You make a mistake in hedging all of this risk things can go very bad very quickly.”
The funds are designed to be volatile. An exchange-traded note is based on senior, unsecured, unsubordinated debt and is designed to provide access to the returns of various market benchmarks.
In this case of the VelocityShares Daily 2x VIX Short-Term Exchange Traded Notes, that product is designed to produce to twice the daily volatiltiy of the S&P 500 VIX Short-Term Futures Index ER, minus an investor fee.
In return, though, the funds are also extremely risky. ETNs don’t reflect ownership of any debt instruments. Such notes, NYSE Euronext notes, are “designed to track the total return of an underlying market index or other benchmark, minus investor fees.
The creditworthiness of an ETN is itself not rated, but instead is based on the creditworthiness of the issuer, according to the exchange operator.
The suspension has already had an impact on prices, according to Strauts, with the value of the notes declining 3%. Because there is high turnover in these notes, a key pillar of their value is the willingness of the backer to continue issuing them.
Credit Suisse declined to comment beyond the announcement, but in a statement the firm said that it “believes it is possible that the temporary suspension of further issuances may cause an imbalance of supply and demand in the secondary market for the ETNs, which may cause the ETNs to trade at a premium or discount in relation to their indicative value. Therefore, any purchase of the ETNs in the secondary market may be at a purchase price significantly different from their indicative value.”
Strauts says that prices will continue to decrease as long as issuance is suspended, and more managers leave the market, which might actually solve the problem. However, going forward this might be a sign that such a risky product may need more than one backer.