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With Barclays' £450 million loss on structured notes, the VXX plot thickens

Barclays abruptly stopped supporting two of its most popular exchange-traded notes, VXX and OIL, just a few weeks ago.

Many were perplexed by the decision to halt share creation linked to the notes, which were designed to mimic Vix volatility futures and crude oil prices, respectively. VXX, in particular, was a popular trading tool with nearly $1 billion in assets. Trading also went haywire as a result. 

According to Barclays, "this suspension is being implemented because Barclays does not currently have enough issuance capacity to support additional inventory sales or ETN issuances. These actions are unrelated to the Ukrainian crisis or any issue with the underlying index components' market dynamics. Barclays expects to reopen ETN sales and issuances as soon as additional capacity for future issuances is available."

In an effort to explain why the bank abruptly stopped supporting the two ETN, in a recent statement, Barclays said: "Barclays Bank PLC ("BBPLC"), a subsidiary of Barclays PLC ("BPLC"), is a frequent issuer of structured notes and exchange traded notes in the United States and elsewhere as part of its structured products business.

These securities are frequently issued to meet current and anticipated client demand. BBPLC has determined that the securities offered and sold under its US shelf registration statement during a period of approximately one year exceeded the registered amount (the "Affected Securities") 1, giving rise to a right of rescission among certain Affected Securities purchasers, requiring BBPLC to repurchase the Affected Securities at their original purchase price. As a result, BBPLC has decided to offer eligible purchasers of the Affected Securities a rescission offer. BBPLC will publish the details of the rescission offer in due course.

Barclays expects rescission losses (net of tax) of c.£450 million based on current market prices of the Affected Securities and an estimated pool of potentially eligible purchasers electing to participate in the rescission offer."

According to a footnote, Barclays had a maximum offering size of $20.8 billion for its ETNs, which it exceeded by about $15.2 billion. Quite the blunder. Those securities must now be bought back at their original purchase price, resulting in a £450 million loss.

Also, Barclays only provides its estimated post-tax loss, implying that the nominal loss is much higher. The blow will even push Barclays' £1 billion buyback program into the second quarter.

ETNs are exchange-traded products, but unlike the more well-known exchange-traded fund, they function as a synthetic debt security issued by a bank that then uses derivatives to ensure that it tracks the underlying index. The complicated beasts can be extremely profitable, thanks to the management fees as well as the numerous trading opportunities they provide.

The iPath Series B S&P 500 VIX Short-Term Futures ETN and the iPath Pure Beta Crude Oil ETNs — or, to give them their formal names, the iPath Series B S&P 500 VIX Short-Term Futures ETN and the iPath Pure Beta Crude Oil ETNs — continue to trade on the New York Stock Exchange and the CBOE, respectively, even though Barclays is no longer creating new shares

As this Bloomberg article explains, they both became untethered from their underlying reference indices on March 14. According to Goldman Sachs, VXX has options referencing six times its share count, which is more than twice the ratio of any ETF or stock except the HYG and XRT, which are junk bond and retailer stocks ETFs, respectively.

"Barclays has commissioned an independent investigation into the facts and circumstances surrounding this matter, including the control environment surrounding such issuances, among other things. Separately, regulatory authorities are conducting investigations and issuing information requests," according to a new statement by Barclays.



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