Barclays keeps close eye on problematic premium seen for its crude oil ETN

By Emma Trincal

New York, Jan. 22 – A notification from Barclays Bank plc that its iPath S&P GSCI Crude Oil Total Return index exchange-traded notes were trading at a premium puzzled market participants – who noted with surprise that the Wednesday announcement revealed that the security wass inflated compared to the value of the distressed underlying it is designed to track.

Up when oil plummets

The bank disclosed that the intraday market prices of the ETN on the exchange were higher than the intraday indicative value.

The indicative value reflects the price of the commodity. Also called daily redemption value, it is calculated from the underlying index level, minus an investor fee. On the other hand, the price on the exchange reflects the price of the security itself.

The amount of premium, according to Wednesday’s press release, was substantial.

From January 1 to 19, the closing indicative value decreased by approximately 30% from $5.67 to $3.95 per ETN, while the closing price of the ETNs on the exchange decreased by only approximately 11% from $6.26 to $5.58 per ETN, the bank said.

This represented an ETN price trading at a 41% premium to the closing indicative value during that period.

The ETNs currently trade on the NYSE Arca stock exchange under the ticker symbol “OIL”.

“In a perfect world, there shouldn’t be a disconnect between the two,” said a market participant.

“Gaps like that are one of the reasons investors are wary of ETNs in general.”

Risky gaps

“I don’t know why it’s trading at a premium. It’s kind of odd,” said an industry source with knowledge of the ETN market.

“I don’t know why there is such a high premium, but I know it represents a major risk.

“Barclays is not required to warn investors. There is no regulation requiring issuers to notify the market of the existence of a premium in an ETN.

“They’re taking the initiative to do that because of the risk to investors. They’re acting as a good corporate citizen.”

Barclays said that investors buying ETNs should know that they are paying “significantly” more than the intraday indicative value. Given that secondary market premiums are volatile, investors should not assume that the ETNs will always trade at a premium, it warned.

“Somebody buys the ETN on the exchange. They lose the premium. They’re going to get creamed. That’s what Barclays is trying to let people know,” the industry source said.

But it remains unclear what had created the premium in the first place as oil prices are collapsing.

This source did not rule out renewed appetite from investors for the distressed asset class.

“It could be because there is more demand for this oil ETN right now. Maybe some people think oil will do a turnaround. How low can it go? That’s just my theory about it but I don’t know for sure,” he said.

Second warning

Another possibility unfolded in a second notice issued by the bank on Friday. In its “further guidance” Barclay’s announced a reduction of the premium announced two days before.

As of Jan. 21, the bank signaled a drop in the premium to 16%.

A look at the underlying index chart shows no price move between Jan. 19 and Jan. 21. Only on Friday did the index rise 13.5% as a result of an oil rally.

Once again the premium fluctuation did not appear to be guided by the fundamentals in oil, sources said.

A more valid explanation could be Barclays’ effort to control the situation, some sources said.

Inventory sales

In Friday’s announcement, Barclays also informed investors that it was attempting to reduce sales of ETNs from its inventory.

“In recent weeks, the relationship between the market price of the ETNs, on the one hand, and the intraday indicative value or daily redemption value, on the other hand, has been exceptionally volatile,” Barclays said in its second press release on Friday.

“The effect of this volatility is magnified by the large number of ETNs outstanding. Currently, there are 139 million ETNs outstanding, representing the highest exposure to the underlying index since the inception of the ETNs. In its capacity as a market maker, Barclays is currently limiting (but not closing) the sale of the ETNs from inventory.”

The industry source said that such “limitation” may not have influenced the size of the premium. But it certainly showed that Barclays was doing its best to control volatility.

Damage control

“First they warn investors about the premium. They explained that they can get hurt if the premium disappears,” said this source.

“Then they mention that there is a large amount of ETNs outstanding: 139 million ETNs. That’s a lot of people who could get hurt by the disappearance of the premium.

“If the premium disappears suddenly and if you have a lot of ETNs out there, there is substantial risk. To reduce that risk, they just try to keep the outstanding down.”

He explained that in doing so, Barclays was not “suspending” the issuance of new shares.

“This is different. They’ll continue to purchase the ETNs but they may not resell them, limiting the sale of ETNs from the inventory.

“They’re not trying to reduce the premium. They’re simply trying to reduce the potential damage if the premium disappears by reducing the amount of available ETNs.”

No suspension

But it remained unclear for this source what created the premium in the first place. Also unclear was what had caused the reduction of the premium in the space of two days.

For this source, limiting sales without suspending issuance was probably not a valid reason for the premium to shrink.

“I don’t’ think what they’ve said about their inventory has anything to do with the premium. I don’t even think they can do much about the premium itself.”

Others were unsure.

“It’s hard to tell why there’s a premium and still a premium when oil is tanking,” a market participant said.

“We’ve seen many issuers, including Barclays, who have ceased creating new units. But it doesn’t seem to be the case here.”

Flash back

This source said investors’ guesses about what the issuer is about to do next and potentially along with rumors go a long way to fuel volatility.

“Everybody is still thinking of what happened to Credit Suisse with TVIX.”

In 2012, Credit Suisse stopped issuing new VelocityShares Daily 2x VIX Short-Term ETN s, which created a significant premium. The ETN was listed in the NYSE Arca under the symbol “TVIX.”

When the bank resumed issuance about a month later, the price collapsed.

“Credit Suisse stopped creation and all of a sudden, the ETN traded at 80% over its value.

“When they restarted the premium vanished within one or two days. The premium first declined 30% based on the rumor that they were coming back. When the bank announced that it was actually reissuing new notes, it declined 30% further.

“That’s why Barclays is cautious. It’s precaution. They want to warn investors of the risk.”

Big picture

The disparity between the ETN price on the market and its indicative value are not to the liking of traders. They also underline a deeper problem at the root of some of the difficulties faced by ETN issuers in general.

“Several banks have ceased issuing new ETNs for accounting reasons,” he said.

“The ETNs are not considered long-term debt by the regulators because anyone can redeem any time. They don’t receive capital relief,” he said.

“Several issuers have closed the creating process which has led to deviating prices.”

“Given those mispricings and price discrepancies, there is a lack of enthusiasm among investors. When a bank stops issuing, it can quickly impact the price and create a risky premium.

“At the same time, you have some issuers who want out due to the regulatory pressure they face in this market. It makes investors more and more suspicious about ETNs. That’s some kind of vicious circle.”

Barclays declined to comment.

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