Investors Can Face Peril When ETNs Delist

Delisting of two large oil ETNs could leave some investors trapped.

Reviewed by: Trevor Hunnicutt
Edited by: Trevor Hunnicutt

New York (Reuters) – Investors are rushing to get out of a top exchange-traded note before it stops trading publicly, and those who fail to find a buyer may be stuck for years in a widely misunderstood product.

Credit Suisse's $1.1 billion VelocityShares 3x Long Crude Oil ETN (UWTI) is poised on Thursday to become the largest-ever note to be delisted from U.S. exchanges.

Investors hold $22 billion of U.S. exchange-traded notes, which, like debt, constitute a pledge by an issuer. Payouts are based on the performance of the underlying asset, but the notes do not "hold" those assets, unlike ETFs, to which they are often compared.

UWTI is widely used by mom-and-pop investors, many of whom are unaware of these differences and may find out too late, analysts say.

Banks, under regulatory pressure to cut risk since the financial crisis, have been issuing fewer ETNs and delisting existing ones to focus on their core businesses.

No New Redemption Option

It is rare for a delisting to come without a new redemption option for investors who retain the product. Credit Suisse's move may make investors wary of ETNs.

"The benefits of ETNs, in most segments of the market, are not that great," said Michael Iachini, managing director of mutual fund and exchange traded fund research at Charles Schwab Investment Advisory. "It's not a great loss."

Upon delisting, ETF holders are typically paid out in cash, while ETN holders are at the mercy of the issuer. After that, investors looking to sell would be forced to find a buyer "over the counter," where investors are not guaranteed anything close to what the notes are worth.

Several traders and analysts expect Credit Suisse to announce plans to effectively redeem the remaining notes for cash, but the bank has not said whether it would do so.


89 ETNs Out Of 300 Issued Closed

Over the last decade, 89 ETNs have closed, out of a total of nearly 300 issued, according to fund researcher Morningstar. The largest closure was last year, when Royal Bank of Scotland ended its stock-tracking $478 million U.S. Large Cap Trendpilot ETN.

Investors pulled nearly $675 million from UWTI in the two weeks through last Wednesday, according to fund researcher Thomson Reuters Lipper. The march toward their delisting has occurred despite a massive run-up in oil prices that has boosted the ETN's price.

Credit Suisse said in a Nov. 16 statement it would delist the ETN to better align "its product suite with its broader strategic growth plans."

Average UWTI Holding Period 6 Days

Investors hold UWTI for six days, on average, according to Deutsche Bank Securities. Those who do not sell UWTI this week could be forced to hold the notes for years, since they do not officially expire until February 2032.

Credit Suisse, which in 2014 said it would wind down its commodities trading, declined to comment on plans for the ETN.

VelocityShares, a Janus Capital Group unit that provides services for the notes, also declined to comment.

Investors can book huge profits during oil price volatility, such as when the Organization of the Petroleum Exporting Countries agreed last week to curb crude production in a bid to support prices. Prices soared.

UWTI, which promises to multiply the return of an oil futures index by three, leapt 25% on Wednesday alone.

Inverse Cousin Also Delisting

A smaller related ETN, the $230 million VelocityShares 3x Inverse Crude Oil ETN (DWTI), is also delisting Thursday. The notes actually attracted $60.2 million in the latest week, Lipper says.

Yet "leveraged" ETNs' volatile results have led to disappointments. Brokers have been sanctioned for selling the products to retail investors for whom they were not suitable.

Credit Suisse was sued by investors who owned a leveraged ETN after new issuances of the notes were suspended. A federal appeals court in 2014 ruled in favor of Credit Suisse, saying no reasonable investor could have read its disclosures without understanding the notes' risk.

Institutions account for only 16% of the funds' owners, according to Deutsche Bank analysis. TD Ameritrade, a retail-focused broker, said UWTI was among the most popular securities traded by millennials last year.

Issuers are not always willing to help after a fund is delisted, says Mariana Bush, head of closed-end fund and exchange-traded product research at Wells Fargo Advisors, who has helped financial advisors at the bank liquidate positions in delisted ETNs.

"It was a nightmare," she said. "Investors should be aware of it and should try to think about an exit strategy."


Trevor Hunnicutt is a staff writer for Reuters.