Starting Monday, Billions In ETNs Are No Longer Marginable Collateral

Tyler Durden's picture

When is marginable collateral not marginable collateral? When it is an ETN, or Exchange Trade Note: the cousin of the Exchange Traded Fund (ETF). The very mutated, and unabashedly evil cousin of the ETF that is.

At least such is the view of US brokerage Interactive Brokers (and certainly not of the ECB where as is widely known blocks of feta cheese and olive oil are perfectly acceptable forms of collateral).

First, what exactly is an ETN?

Here is the IB definition:

ETNs are not equity shares but rather a form of unsecured debt whereby the issuing institution promises to pay a return linked to a market index or other benchmark. As ETNs generally do not buy or hold assets like an Exchange Traded Fund (ETF), their returns are realized through holdings of derivative contracts such as options, futures and swaps. While ETNs trade on exchanges in a manner similar to equities, their issuance, redemption, credit, liquidity and performance characteristics are structurally distinct from other Portfolio Margining products.

In other words, something oddly reminiscent of the equity tranche of a synthetic CDO, in which case alarm bells should already be going off at the thought that a CDO squared can be the collateral used to back other margined purchases, which by that definition makes it what, a CDO cubed?

Here is some additional information on ETNs from Bloomberg:

ETNs are exchange-traded notes, cousin of the far better-known exchange-traded fund, or ETF, and they have been at the center of some drama lately. Despite a drop in new launches and critical articles in the financial news media, ETNs are growing at twice the rate of ETFs -- and not many things have grown faster than ETFs, except maybe the Internet. Total ETN assets jumped 47 percent, or $8 billion, over the past 12 months, to $25 billion, compared to about 25 percent for ETFs.


What makes all this so curious is that almost everything ETNs track you can get in an ETF, with less risk. So why on earth have these things captured $25 billion in assets, much less $25?


The answer lies largely in their tax treatment, which appeals to income-oriented investors.


What Are They?

Like ETFs, ETNs trade on an exchange, track an index and provide real-time, intra-day updates on the underlying value of the product (think of that as the fair value for the ETN at any given moment in time). Unlike ETFs, they don’t hold an underlying basket of securities or futures contracts. Instead, they’re unsecured debt obligations from a bank or other financial institution and promise to match the performance of a certain index over a specified period. If the issuer defaults, investors could be wiped out. Lehman Brothers had a couple of ETNs. It’s unclear whether investors, which were mercifully few, got their money back.


Custom-Made Products


Custom-tailored ETNs, designed and launched with one investor in mind, account for about $3.4 billion of the total, or 13 percent. These products are the fastest-growing area in the ETN world and got about half of that $8 billion 12-month asset growth. One example is the Barclays ETN+ FI Enhanced Global High Yield ETN (FIGY). It provides leveraged exposure to the MSCI World High Dividend Yield Index. It was created for Fisher Investments, which worked with Barclays to construct it so that it would fill specific investment needs for the firm's clients. Fisher Investments accounts for 97 percent of the $1.5 billion in this particular ETN.


The High-Octane Stuff


ETNs built around volatility indexes are the most hard-core of the hard-core, and a big reason ETNs get a bad rap. These ETNs account for 10 percent of total ETN assets and asset growth was flat over the past 12 months. However, they account for 75 percent of ETN trading volume. These things mostly lose money over the long term, but traders love them for fast, liquid and convenient exposure to different variations of volatility.


An example of what can go wrong here is the VelocityShares Daily 2x VIX Short-Term ETN (TVIX). The Chicago Board Options Exchange Volatility Index, known as the VIX, is a gauge of U.S. stock volatility. The VelocityShares ETF returns two times the daily return of the VIX futures contracts. TVIX is a combination of three things individual investors should stay away from: VIX, the futures market and leverage. Not only that, but TVIX once stopped issuing new shares for a short period, which caused its price to become wildly unhinged from its underlying net asset value. Some retail investors lost large chunks of money.

After reading the above, one should hardly be surprised at the following announcement from Interactive Brokers:

Pursuant to a recent decision by FINRA whereby Exchange Traded Notes (ETNs) will no longer be eligible for Portfolio Margining, these securities, including options having an ETN as an underlying, will be phased out of the program by OCC during the week of May 19, 2014.

In fact, a far bigger surprise is that FINRA and other regulators had allowed these synthetic, self-destructing non-assets to be used as margin collateral in the first place. However in a New Normal world, in which everything is rehypothecated countless times, it becomes clear why even these so-called assets had to be recycled into even more purchasing power. And so they were, until next Monday, when first IB and shortly thereafter all other brokers will have no choice but to phase them out as marginal products.

More from IB:

What This Means to You


You are receiving this communication as you maintain a Portfolio Margining account and either currently hold or have recently held positions which are subject to phase out. Once phased out, these securities will be margined in accordance with Reg. T, the effect of which will likely result in an increase to your overall margin requirement. Any increase will result from one or more of the following computational differences:


1. Portfolio Margining offers a risk based computation through which requirements are determined assuming price changes as low as 15%. This compares to Reg. T under which these securities will be subject to initial and maintenance margin requirements of 50% and 25%, respectively.


2. Portfolio Margining recognizes hedges and offers margin relief between qualifying long and short positions that Reg. T does not. As example, securities which are functionally identical but have different leverage objectives such as the PowerShares DB Crude Oil Short ETN (SZO) and the PowerShares DB Crude Oil Double Short ETN (DTO) are afforded full risk offset if one is long and the other short. Similarly, Portfolio Margining offers partial offset between securities which are distinct but have historically exhibited high positive correlation. As example, a position in the PowerShares DB Crude Oil Short ETN (SZO) and the iPath S&P GSCI Crude Oil TR Index ETN (OIL) would be eligible for partial offset if one is long and the other short.


3. The requirement for options under Portfolio Margining is determined through use of a pricing model whereas under Reg. T options are treated in a manner similar to that of the underlying stock. As a result, requirements may be substantially higher under Reg. T., particularly for options which are deep out-of-the-money and with little time remaining until expiration. In addition, unlike Portfolio Margining, Reg. T provides option margin offsets only under a limited set of defined strategies.


When Will This Change Take Place?


OCC will begin removing products from Portfolio Margining starting May 19, 2014 and expected to have all products removed by May 23, 2014. They have not published a schedule detailing which products will be removed on which day.

More importantly, this development means that suddenly market participants will have to come up with $25 billion in new collateral, such as cash, to replace the elimination of ETNs as a margin class. In this hyper levered market, that may be harder than it sounds.

Finally, does this announcement apply to you? If you hold any of the 187 "securities" listed below the answer is yes, and get ready to either sell the security or add an identical amount of cash to your account.

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disabledvet's picture

Banks have been getting slammed the last two months.
If traders start getting hit too we'll see if fear turns to rout or not.

cifo's picture

Trade ETNs, because a sucker is born every minute.

Vampyroteuthis infernalis's picture

Black Swan? Seems like WWIII in the Ukraine matters not to the markets.

0b1knob's picture

By the same logic, shouldn't mREITs, business developement companies, and bond ETFs be declared non-marginable?

Soul Glow's picture

I wonder what percentage of licensed traders know this is happening.

Tao 4 the Show's picture

Question would seem to be whether most traders use these ETNs to margin themselves long or short, and in which markets. We should see soon. Of course, this would also represent a good play for those with insider information.

RadioactiveRant's picture

I can't see the collapse coming from within the US/EU, they're all in cahoots and no body inside the club wants the party to end so will co-operate and keep their mouth shut. The torchpaper will be lit possibly accidentally by an outsider like China scrabbling for cash and liquidating, or every other towel head in India trying to buy an ounce of gold because Modi has nationalised the banks or delcared war with nuclear armed neighbour Pakistan.

NotApplicable's picture

I hate it when Bloomberg starts talking about tax advantages, then doesn't talk about them.

ebworthen's picture

Does this mean less speculative leveraging of margin debt and jiggering of momo churning sector rotation - or does Wall Street have some other toy to do that with?

More ETF's?  Or will it be something like "EFL's" or "Exponential Fucking Leverage" funds?


RadioactiveRant's picture



  • The individual brokers or their major leveraged clients will be deemed to big to fail and Mr Yellen opens his wallet.
  • The sells are matched to anonymous public buyers (Feb, ECB, BoE, SNB, or any other of Medusas heads)

$25bn isnt going to stop this train.

medium giraffe's picture

Economic vapourware.

Rainman's picture

So this change is catnip for the shorts....??

This entire fiat marketplace is loaded with IEDs. Disarming all of them without a detonation is unpossible.

Frederick N. Chase's picture

IB learned and remembered something after almost buying MF Global in Fall 2011.

Panafrican Funktron Robot's picture

Interesting that they chose to focus on TVIX, instead of the much more widely traded VXX and XIV.  Mass exodus to VIXY/SVXY/UVXY incoming. 

Panafrican Funktron Robot's picture

For those unfamiliar, VXX + XIV average volume is about half that of SPY.  A lot of people use VXX as a hedge against their longs.  This could be a complete disaster.

MeelionDollerBogus's picture

also HVU on TSX moves like UVXY. My equation (219 = C) C = SPY x HVU 1/11 can be re-applied to UVXY in a crude manner by using a ratio of 9.1, so UVXY / 9.1 = HVU but remember UVXY is USD & HVU is CAD. For that equation over a longer period C has been anywhere from 216 to 224 and in short time periods that makes a huge difference for trades. As a no-expiry hedge vs SPY,DIA,QQQ and anything moving like them (financials: GS,JPM,C,BAC,MS) most of the time, HVU & UVXY can still be helpful provided prices don't unhinge beyond a day or two & become uncorrelated .


Savyindallas's picture

people selling longs decreasing the price? Or shorts covering in creasing price?

l.kimbot's picture

I work for a living.  So 20th century.  

Ness.'s picture

What is that God awful smell?  Dammit.  I think the E-Trade baby needs a new diaper... I'm pretty sure he just shit all over himself.

MeelionDollerBogus's picture

"ETNs are growing at twice the rate of ETFs -- and not many things have grown faster than ETFs, except maybe the Internet."

That's all I need to hear.


kenezen's picture

Zero Hedge must know the inconvenience this has caused the small investor is far less than the massive portfolios of derivative product held by the major banks that continual seek offsetting hedge instruments to at least pretend to offset the risk of hundreds of trillions of dollars in Derivative product. This upsets the balance. it is interesting when I was out talking about financial product a small petite lady of probably in her eightieth years asked about FDIC and derivative storage in that program. I responded that sadly the large banks had put reportedly trillions of dollars of Derivative product into FDIC accounts. I was shocked that question had come from that incredibly up to date investor!


medium giraffe's picture

Hazard a guess as to what happens when a $25B market dries up overnight?  As  you point out, used in concert with ETNs they can be used to offset risk within hedge funds.  Without holding one, it might not make any sense to your risk profile to hold the other.  Many of these ETFs are go to instruments for big wealth management firms.  What happens to these ETFs?


Boxed Merlot's picture

Hazard a guess as to what happens when a $25B market dries up overnight?...



The fed pumps frn35B into a Belgian account to offset and sweeten the punchbowl? 

It's all ether anyway.

scubapro's picture



the real target are inverse etn's.   the headliner is the exotice  double levered vix, but finra is already preparing for a substantial mkt decline.   they do not want people to be able to 'be short' unless  they do so in the traditional way which leaves them at risk of short squeeze.   when owning SH,  you only risk what you have put up.  when actually short spy, the downside is theoritically much higher.   

also retail has no understanding of daily decay or counterparty risk--the sponsor.   this change by finra is just the usual disallowing retail or independent investors from playing in an area the ib and b/ds want to keep for themself, namely  downside participation, hedging, and commodiites.   after all retail only needs to remember to buy and hold, or as cramer put it recently, dont chase a bear--theres nothing you can do just buy more 'higher-quality' stocks.

medium giraffe's picture

Makes sense after '08.  Outsider downside participation threatened DB.  A lot of money changed hands.

vote_libertarian_party's picture

This pertains to VXX.


Is it possible there could be a super spike for a few days?  I saw a website that said short interest was 66% of avg daily volume.


Lets say shorts are max margined and longs are not.  Could a big rush over short covering cause a spike for a few days? 

flyingcaveman's picture

Could this be used as an excuse for precious metals to rise?  Investors need collatteral sounds much better than prices skyrocket because the fix is ending.