The Lehman Bros. ETN Fallout

September 13, 2018

Did Investors Ever Get Their Money Back?

As holders of unsecured debt, investors in the Opta ETNs had few options to recover their money save the bankruptcy courts. And for a long time, nobody really knew when—or if—that would ever work.

It took more than four years of bankruptcy proceedings for Lehman to begin paying out claims to its "Class 3" creditors, or the holders of senior debt (which included the Opta ETNs). Those payments began in April 2012, and continue to this day.

According to the bankruptcy filings, over the course of the past six years, creditors for the Opta ETNs received a total of 44.5% of their total allowable claim. That comes to $2.14 million for RAW, $2 million for EOH and $1.85 million for PPE.

It's still a 55.5% loss on investment.

Different Ending For Bear Stearns's ETPs

Intriguingly, it didn't have to end this way. And in fact, in another high-profile insolvency, it didn't.

Bear Stearns, which nearly went bankrupt in March 2008, also had offered exchange-traded products, the aforementioned BSR and YYY. When J. P. Morgan bought Bear Stearns, they honored Bear's debt obligations, including that of BSR, and maintained trading in YYY for several months to come.

But eventually, J.P. Morgan closed these products, too. YYY, which was the industry's first actively managed ETF, folded in October 2008 after failing to attract much in the way of assets. (The ticker was later resurrected as the YieldShares High Income ETF, a fund still trading today.) Too much of Bear Stearns' thunder over the innovative product had been stolen by its bankruptcy troubles and by Invesco PowerShares, which had launched its own actively managed ETFs weeks later.

J.P. Morgan kept BSR trading for several more months, but it liked the concept of a master limited partnership ETN so much that it opened its own version, the J.P. Morgan Alerian MLP Index ETN (AMJ). AMJ was even based on the same index as BSR, and it remains popular with investors to this day, with $3.3 billion in assets under management, the second-largest of any MLP ETP.

As for BSR, it was delisted, but not liquidated, in June 2009.

Other Would-Be ETN Providers Pull Out

Until Lehman's collapse, ETNs had appeared to be a promising new growth area of the exchange-traded product market. 2008 saw a record pace for ETN launches; according to ETF Database, 59 ETNs had been issued that year—all before Sept. 15.

In the wake of Lehman's collapse, other would-be providers couldn't run from the ETN structure fast enough. Invesco PowerShares, for example, stepped away from plans to launch its own ETN suite the very same week it became obvious Barclays wouldn't bail out the Opta ETNs (read: "ETN Providers, Investors React With Prudence, Not Panic").

In the 15 months following Lehman's bust, only nine ETNs launched—one of which was AMJ, J.P. Morgan's BSR clone.

Investors, too, had become disillusioned with the exchange-traded note as an investment vehicle. Redemptions surged in the Market Vectors Chinese Renminbi/USD ETN (CNY) and the Market Vectors Indian Rupee/USD ETN (INR) in the weeks post-Lehman. Flows into the biggest notes, like the iPath Bloomberg Commodity Index Total Return ETN (DJP) lagged for months.

While eventually new issuers would tiptoe back to the ETN vehicle—Royal Bank of Scotland, VelocityShares, and even Invesco PowerShares launched their own notes—no new issuer would again launch the same breadth and diversity of products as Barclays or Deutsche Bank, the issuers who got in before Lehman's collapse.

Many of those who did launch ETNs post-Lehman eventually had to shut them down. For example, of the 64 ETNs launched in 2011, only 12 have survived to date.

ETNs: Not Dead Yet

That said, the exchange-traded note has found its uses. Whereas in Lehman's day ETNs were the preferred vehicle for commodity exposure, today they've found popularity among traders looking to make volatility and leveraged bets.

Yet the failure of the Opta ETNs continues to cast a pall over the ETN space. To date, the total assets invested in ETNs are only $22.4 billion—or just 0.61% of the $3.68 trillion invested in all ETFs.

Could we ever see a repeat of what occurred with the Opta ETNs? Maybe. Banks are more tightly regulated these days, but the same risks remain in ETNs as existed back in 2008. What was an unsecured debt obligation remains just that today. So it's possible, perhaps, but not likely.

Then again, Lehman's collapse was considered possible, but not likely as well.

Contact Lara Crigger at [email protected]

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