Morgan Stanley joins U.S. banks’ regulator-driven exodus from ETNs – but a return is possible

By Emma Trincal

New York, July 1 – Morgan Stanley this week became the third U.S. bank in the past month to announce that it is putting its exchange-traded note program on hold – but they may not be out of the market for good.

Even as overseas-based banks continue to sell new ETNs – Deutsche Bank AG, London Branch, for example, added another $50 million to its FI Enhanced Global High Yield exchange-traded note program on Wednesday – their U.S.-headquartered competitors may be able to return to the market with new issuance structures.

Morgan Stanley announced late Tuesday that it will stop issuing new shares in five outstanding exchange-traded notes, a move that prompted questions and speculation among industry sources.

The suspension was even more talked about as it followed similar announcements from Citigroup and Goldman Sachs only a few weeks ago.

Although one lawyer commented, “This may be just the normal culling of unproductive ETNs,” many had a different take.

“It’s coming from a regulatory capital requirement issue,” a lawyer said.

A source in the ETN market said the decision was due to regulators’ efforts to limit systemic risk in the context of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was voted to avoid further taxpayer bailouts in the event of another big financial crisis.

“Those ETNs have put options. The notes can be put back within a year. It’s considered short-term debt by the regulators,” he explained.

“It’s part of the resolution planning mandated by Dodd Frank,” the source said.

The law requires banks to periodically submit resolution plans to the Federal Reserve Board and the Federal Deposit Insurance Corp. The plans, known as “living wills,” must describe the company’s strategy for “rapid and orderly resolution in the event of material financial distress or failure of the company,” according to the Fed’s website.

The ETNs suspended by Morgan Stanley will continue to trade on the NYSE Arca but no new notes will be issued. They are the following:

• Morgan Stanley Cushing MLP High Income Index ETNs due March 21, 2031 (NYSE Arca: MLPY);

• Market Vectors - Double Long Euro ETNs due April 30, 2020 (NYSE Arca: URR);

• Market Vectors - Double Short Euro ETNs due April 30, 2020 (NYSE Arca: DRR);

• Market Vectors - Chinese Renminbi/USD ETNs due March 31, 2020 (NYSE Arca: CNY); and

• Market Vectors - Indian Rupee/USD ETNs due March 31, 2020 (NYSE Arca: INR).

Citi, Goldman too

On June 15, Citigroup Inc. made a similar suspension announcement for three series of C-Tracks ETNs. These ETNs, which will also continue to trade on the NYSE Arca, were as follows:

• C-Tracks Exchange-Traded Notes Based on the Performance of the Citi Volatility Index Total Return due Nov. 12, 2020 (NYSE Arca: CVOL);

• C-Tracks Exchange-Traded Notes Based on the Performance of the Miller/Howard MLP Fundamental Index due Sept. 28, 2023 (NYSE Arca: MLPC); and

• C-Tracks Exchange-Traded Notes Miller/Howard Strategic Dividend Reinvestor due Sept. 16, 2024 (NYSE Arca: DIVC).

On June 9 Goldman Sachs Group, Inc. announced that it will suspend any further issuances of its GS Connect S&P GSCI Enhanced Commodity Total Return Strategy Index ETN due 2037 (NYSE Arca: GSC).

These suspensions account for all the ETNs issued by the three banks, according to Prospect News data, with the exception of a small ETN based on the S&P 500 Oil Hedged index for which Morgan Stanley registered just $10 million in 2011. The only other U.S. bank active in ETNs, JP Morgan Chase & Co., had two ETNs, one on the Alerian MLP index and a double short US 10-year Treasury futures exchange-traded note but has not registered new notes since May 2012, according to the data. It also registered a $25 million ETN in 2008.

“It’s getting crowded here,” said the lawyer of the suspensions.

A regulatory issue

“Look, there is no economic factor behind that. It just happens that all ... ETNs have put options,” the source said.

“Regulators don’t like to see too much short-term liabilities.

“Since the financial crisis banks have limited their issuance of short-term debt,” the ETN source said.

Regulators have pushed banks to hold highly liquid assets to meet short-term obligations. On the other hand, banks’ short-term liabilities have been perceived as adding some level of systemic risk, sources said.

A market professional commenting on Morgan Stanley’s news release said: “It could be Morgan Stanley’s risk management oversight group wanting to limit exposure in turbulent markets. It could also be that the firm’s treasury department wants to limit its issuance in 25 to 30-year paper, or that ETNs won’t comply with perceived new TLAC classifications that may someday be enacted.”

He was referring to the “Total Loss-Absorbing Capacity Standards” stipulated by Basel III stating that long-term debt “cannot be called at short or no notice.” Such definition excludes ETNs from the definition of long-term debt regardless of their often long maturities since they are putable any day.

Given the three announcements coming from three different banks, market participants concluded that performance was unlikely to be that factor that led all three to suspend issuance of new ETNs.

“It has nothing to do with the economics of these deals. It’s all regulatory as far as I know,” the lawyer said.

“It’s not even clear if it’s due to Basel or Dodd Frank. Resolution plans are definitely part of the picture. But firms are taking their own views on how to implement those capital requirement regulations. People are getting different guidance on different issues.”

While the rules may be confusing, banks have embraced the notion that issuing short-term debt is not best in terms of balance sheet efficiency.

The liquid coverage ratio, a technical term from Basel, makes it clear that banks issuing short-term debt are required to maintain more capital, another legal source said.

Fed’s rulings

A bank stock analyst criticized the unintended consequences of the new capital requirement standards. One of the negative effects, he said, could be that in order to avoid a repeat of 2008’s “too-big-to-fail” dilemma the Fed may have added liquidity to the long list of potential risks in a financial crisis scenario.

“Basel sets the guidelines. Dodd Frank sets the guidelines. It’s up to the Fed to convert these guidelines into specific rules. They keep issuing these rules on a regular basis,” said Dick Bove, bank analyst at Rafferty Capital Markets.

“Over 200 rules have already been put in place and 400 more have yet to follow.

“The Fed views that short-term debt is a systemic risk to the U.S.

“It forces banks to significantly increase the collateral required on their short-term borrowing to make it unattractive for banks to issue short-term paper.

“The Fed has created a new system that prevents banks from borrowing money in the short-term markets. So now they must borrow long-term. But they’re asked to lend short term. It’s insane. They borrow long term to lend short term. They turned the U curve.”

Life goes on

What does the future hold for ETN issuers if their debt is now under the radar of regulators? some sources asked.

New issuance structures are likely the solution.

“It’s not the end of ETNs, absolutely not,” the lawyer said.

“You can issue them out of a different registrant.

“It’s a regulatory story. But the bank regulators target the holding companies, not their subsidiaries. It’s the holding companies that are mandated to come up with resolution plans to resolve crises. They are the ones viewed as systemic entities. That’s why the regulators are focusing on what’s happening at the parent company level.

“If a bank takes the view that they can’t issue ETNs out of the holding company, they can always register out of a subsidiary and issue new ones.”

Foreign banks stay active

Foreign banks issuing ETNs in the U.S. face a brighter outlook, some said.

First they already are strong in this market, according to Prospect News’ league tables, which lists the top three ETN issuers this year as Credit Suisse, Barclays and UBS.

Those top three issuers have not recently announced issuance suspensions. And they may not be the target of the same rules applying to their U.S. counterparts, the lawyer said.

“They may be under different regulatory regimes. They’re governed by the foreign jurisdictions,” he said.

Bove said that U.S. banks are at a disadvantage.

“The Bank of Switzerland does not make those requirements. They haven’t said to the Swiss banks: you can’t borrow in the short-term markets. To my knowledge only the U.S. does,” he said.

“Look at the primary dealers who provide liquidity for the Treasury market. That’s just an example.

“At the end of the 1970’s, the primary dealers were 36 U.S. companies and one foreign company.

“Today, it’s just seven U.S. companies and 15 foreign banks.”

Spokespeople at Morgan Stanley and Citigroup declined to comment. A call to a spokesman at Goldman Sachs was not returned.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.