ETN Double Dipping With GAZ?

April 03, 2012

Is it fair game for issuers to loan their own ETN? Apparently so.


When TVIX reopened for creations last week, quite a few of us noticed an odd feature of the press release.

Instead of just opening the window, they were going to initially make shares available to an affiliate, who would then loan those securities out to short-sellers. Theoretically, this additional selling pressure would help keep TVIX from trading at too much of a premium.

This got us to thinking. How much money could an ETN issuer make by loaning out shares, rather than making them truly available, and why would any ETN issuer actually do this? It turns out, we already had a great example of this to dig into—and we mean dig. That example is GAZ, the iPath Natural Gas ETN (NYSEArca: GAZ).

GAZ has been closed since the fall of 2009, presumably because Barclays was hitting—or worried about hitting—position limits on its natural gas exposure.

Remember, that’s because GAZ, like TVIX, is an ETN. It doesn’t “own” anything. It’s just a promise to pay a pattern of returns that looks just like a long position in front-month natural gas futures. To hedge that risk, ETN issuers back up each dollar of each ETN they issue with a dollar of exposure to the actual underlying—if they can.

So GAZ closed, because Barclays wasn’t comfortable—or wasn’t capable—of managing the hedge. Over time, the shares outstanding of the ETN declined slightly, as authorized participants redeemed shares, putting the actual shares outstanding below their peak.

They pretty much remained below that peak until a few weeks ago, when the premiums in GAZ went nuts.

Curious Creations in GAZ

The top blue line in the chart above is the shares outstanding. From the first of the year, positive flows have been some 680,000 shares in a fund that’s theoretically closed for creations.

If, for instance, the normal process had been in place, a third party could have shown up with cash for fair value, and then sold its shares at a greater-than-100-percent premium, pocketing enormous instant profits. But with the window closed, supposedly, nobody could do that.

Except, it turns out, Barclays Capital, the issuer.

A spokeswoman from BarCap declined to comment on activity surrounding GAZ.

But officials familiar with the ETN said that the creations implied by the rising share counts were in fact shares issued—effectively—to BarCap itself.

Now, BarCap didn’t sell these and profit the way an AP would. Instead, it loaned these shares out to short-sellers, who would then profit should the premium collapse (and let’s be clear, premiums pretty much always collapse eventually.)

For an ETN issuer, this is essentially a riskless transaction. After all, if BarCap holds the shares in its own account, it doesn’t need to hedge it, as it would only owe itself the ETN’s returns!


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