U.S. Securities and Exchange Commission investigators are reviewing a Credit Suisse Group AG (CSGN) exchange-traded note that became unhinged from its benchmark and whipsawed investors, a person familiar with the matter said.
The VelocityShares Daily 2x VIX Short-Term ETN (TVIX), which seeks to provide twice the daily return of the VIX volatility index, climbed almost 90 percent above its asset value after the Zurich-based bank stopped issuing shares in February. The value of the note, which had risen to almost $700 million from about $163 million at the end of 2011, plunged last week when Credit Suisse said it would begin creating shares again.
The review by the SEC’s enforcement division comes amid heightened scrutiny of exchange-traded funds and notes, which had about $1.2 trillion in assets at the end of February, according to the ETF Industry Association. The European Commission said March 22 that it is examining potential “conflicts of interest” affecting the securities.
The price swings in the VelocityShares ETN highlight the risk posed by disruptions in supply and demand of the notes. Because the notes are normally pegged to underlying assets such as stocks, bonds and indexes, sponsors can create or redeem shares to offset price distortions caused when investors buy and sell them.
The gap between the security’s price and the value of the index it tracks widened after Credit Suisse suspended issuing new shares, causing a supply shortage amid record demand for volatility products that provide a hedge against losses on U.S. equities.
The SEC probe was reported late yesterday by the Wall Street Journal. SEC spokesman John Nester declined to comment, as did Credit Suisse spokeswoman Sofia Rehman in London. The person who confirmed the probe was underway asked not to be identified because the inquiry isn’t public.
Credit Suisse declined 25 centimes, or 1 percent, to 26.18 Swiss francs by 12:58 p.m. in Zurich trading. The shares have advanced 19 percent this year.
The VelocityShares ETN aims to produce twice the daily return of the S&P 500 VIX Short-Term Futures Index, which tracks a trading strategy involving futures on the CBOE Volatility Index. The VIX, as the CBOE gauge is known, is used as a benchmark measure of U.S. equity derivatives and measures the cost of protection from losses in U.S. stocks.
ETFs issue shares that trade on an exchange, and can create new shares or redeem existing ones. Exchange-traded notes, or ETNs, like the one backed by Credit Suisse, by contrast, issue unsecured securities that promise to deliver the return of an index. The issuer, often a bank, typically uses derivatives linked to the index to cover their obligation to shareholders.
If the issuer cannot repay the notes, investors lose their money. Issuers may also decide to stop creating or redeeming shares, which can unhinge the ETN from the security or index it was designed to track, which in this case was the CBOE Volatility Index. The VIX, as the CBOE gauge is known, is used as a benchmark measure of U.S. equity derivatives and measures the cost of protection from losses in U.S. stocks.
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