The breathtaking collapse of major ETNs linked to natural gas
and the VIX index has captured the fancy of adults and
schoolchildren everywhere. Its also raised bothersome question
about why the Securities Exchange Commission (SEC) failed to
prevent a totally preventable fiasco.
The VelocityShares Daily 2X VIX Short-Term ETN (NYSEArca: TVIX)
lost 60% of its value over the past week, while the iPath DJ-UBS
Natural Gas ETN (NYSEArca: GAZ) has followed a similar path. (Pun
Like the Pink Panthers Inspector Clouseau, the SEC has been
notoriously late and clueless in solving the ETN
Here are the key reasons the SEC has failed to properly
supervise the ETN marketplace:
A day late and dollar short:
Why didnt the SEC immediately open up an investigation when Credit
Suisse stopped issuing TVIX notes back on February 21? Why didnt
the SEC investigate the iPath DJ-UBS Natural Gas ETN (NYSEArca:
GAZ), three years ago, when Barclays stopped issuing shares in
From what Ive observed, the SECs market timing is awful and its
partially due to the agencys super tight knit relationship with
Wall Street. Friends regulating friends doesnt serve the investing
Lack of understanding:
If the SEC truly understood the ETN market, they wouldve
immediately recognized that ETN issuers can blindside ETN investors
whenever they create or redeem notes. Did the SEC not realize the
February 21 stunt by Credit Suisse would create instability in TVIX
shares? Did the SEC not know huge distortions between an TVIXs
share price and its underlying assets would likely be triggered?
Did the SEC not read the prospectus?
Unfortunately, Wall Street has done such an outstanding job of
manufacturing confusing financial paraphernalia, it seems
securities regulators themselves dont understand the very products
they are responsible for supervising.
Maybe the real problem with the SEC is how they pick and choose
what securities rules theyll enforce, not necessarily what should
be enforced. Of what value is a litany of securities rules if
theyre never enforced? And which rules did the SEC fail to
uphold? The ETN market is out-of-control, because the SEC has
allowed it to become that way.
The Right ETN Game Plan
ETN issuers have not been able to prevent their products from
trading at massive premiums or discounts and they too share in the
blame. Cleary, Barclays and Credit Suisse, as top ETN issuers, have
flunked in executing their prospectus stated objective for GAZ and
TVIX by making sure their products closely stick to their
If you are investing or trading in ETNs with substantial
premium/discount distortions, be forewarned: You are not making a
directional trade based upon the ETNs underlying benchmark or
index, but rather an arbitrage trade. If youre anything but an
institutional investor with the toolkit to make arbitrage trades,
youre swimming with sharks.
Long before this ETN crisis struck, Ive been warning readers
about the dangers of ETNs.
On September 13, 2011, I wrote 'ETN Market Primed for Disaster.'
The article was published at ETFguide.com and Yahoo Finance.
That piece was followed up by another controversial article I
wrote on November 30, 2011 titled Are you ready for the Great ETN
Meltdown? Then again, on February 13, 2012, I followed up with
Credit exposure for ETNs not going away.
In the December 2011 edition of the
Profit Strategy Newsletter
, we asked Which ETNs Will Blow Up First? In this research piece, I
provided a list of the top 15 ETNs by assets and 15
alternatives. I gave readers plenty of advanced warning,
which shows that fiercely independent research and going against
the Wall Street consensus is a winning formula.(Incidentally, TVIX
was one of the ETNs I advised against.)
Today, theres roughly $17 billion parked in U.S. listed ETNs,
which is almost double the amount that was invested in ETNs in
2010. People have piled into ETNs linked to master-limited
partnerships (NYSEArca: AMJ), Indian stocks (NYSEArca: INP), and
gold (NYSEArca: DGP). But unlike before, the money lost
from busted ETN investments will be much worse.
Ron DeLegge is the Editor of ETFguide.com andAuthor
Gents with No Cents: A Closer Look at Wall Street, its
Customers, Financial Regulators and the Media
. (Half Full Publishing Group, 2011)