Credit Suisse’s XIV Exchange Traded Note (ETN) Loses Big

On February 5, 2018, Credit Suisse’s XIV Exchange Traded note (ETN) essentially evaporated and lost approximately $2 billion in a single day.  Credit Suisse promised investors in its Pricing Supplement that it would publish an estimate of the current economic value of XIV shares every 15 seconds.  Had that been true and accurate, investors would have known that the ETN was going to liquidate, and would not have invested and lost an eye-watering $700 million.  Before delving into what happened with Credit Suisse’s XIV, it is important to have some background.

What is an Exchange Traded Note?

Exchange-traded notes (ETNs) are a type of unsecured, unsubordinated debt security, with no period coupon payments distributed and no principal protections. They act more like a bond rather than a stock.  Similar to exchange-traded funds (ETFs), ETNs are traded on a major exchange, such as the New York Stock Exchange (NYSE) during normal trading hours. ETNs simply track the performance of a specific market index (i.e. The Chicago Board Options Exchange (CBOE) VIX which measures market volatility implied by S&P 500 index options).  The ETNs let institutional investors use volatility in part of their portfolios without actively trading underlying positions every day. When the ETN Matures, the financial institution takes out fees, then gives the investor cash based on the performance of the underlying index.

ETNs are more tax beneficial for long-term investors than their ETF counterparts.  The benefit of an ETN is that the entire gain is treated as a capital gain, this gain is also deferred until it is either sold or matures.  That is something that should not be taken lightly by tax-conscious, long-term investors.

The risks of an ETN lie in the repayment of the principal.  The repayment of principal depends somewhat on how the underlying index performs. If the index either goes down or does not go up enough to cover the fees involved in the transaction, the investor will receive less at maturity than what he originally invested – thus leading to losses.

Credit Suisse’s Misrepresentations

Credit Suisse promised potential investors that it would constantly update the value of XIV.  Credit Suisse also claimed that the value was calculated by S&P in real time from real time prices of VIX futures contracts.  These claims were false and misleading. Credit Suisse misrepresented to investors about the estimated price of the ETN, which cost investors $700 million in less than an hour.  It claimed that it was using the S&P index to estimate future values, but it knew at the time that the S&P index was not capable of being updated every 15 seconds. This lie is significant because in the event that XIV decreased in value of 80%, Credit Suisse would redeem the notes early.  

On February 5, 2018, Credit Suisse’s XIV lost 97% of its value.  Between 4:10pm and 5:09pm, Credit Suisse materially misrepresented the true value of XIV to investors.  Those investors were buying XIV at prices as high as $80 when Suisse was representing to the public that the economic value was $24, but in actuality, they knew the true value was around $4.  Investors of the XIV stood to lose over $700 million as a result of these egregious misrepresentations.

Credit Suisse misrepresented to investors about the estimated price of the ETN, which cost investors $700 million in less than an hour.