How the XIV ETN could have blown up the Credit Suisse bonus pool

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In the 2008 financial crisis, it was structured investment vehicles (SIVs) and collateralized debt obligations (CDOs) that were at the heart of the action. We don't have a new financial crisis (yet), but we do have the steepest fall in Wall Street stocks in six years and a newly popularized acronym. - Following an 85% decline in the value of the VelocityShares Daily Inverse VIX Short-Term exchange-traded note, the XIV ETN is all the rage.

The XIV ETN was issued (and partially held by) Credit Suisse. When the index product plummeted in value after hours last night, CS stood to make a potential net loss of $530m. This would have been equivalent to 82% of the profits in Credit Suisse's global markets division in the first nine months of 2017. It was a realization that contributed to a 6% drop in the Swiss bank's share price this morning.

Credit Suisse's share price has recovered slightly following a statement to the effect that the bank's exposure to the XIV ETN was fully hedged and CS therefore won't be affected by any of the losses relating to it.

Credit Suisse employees need to hope this is so. Bonuses at the bank are currently being finalized before being announced in the next few weeks and Credit Suisse CEO Tidjane Thiam has already warned that they won't be great. The Swiss bank's 2016 bonus pool was $3.1bn despite a big loss on illiquid trades in the first quarter. For 2015, the Swiss bank cut its bonus pool by 36%.  Amidst today's reassurances, it may be worth remembering that Thiam was behind the curve on the previous losses relating to the illiquid trades and that some (potentially disgruntled) insiders have argued that CS is run by a cabal of "yes-men." At the very least, the losses relating to the XIV ETN are likely to trigger lawsuits as investors seek compensation. It won't be the first time - Credit Suisse was subject to a class action related to VelocityShares ETNs in 2012. 

Some market commentators are also suggesting that the latest problems could herald the demise of exchange traded notes that bet against volatility. If so, it could be bad news for VelocityShares, which specializes in constructing the volatility products issued by Credit Suisse, and which employs an assortment of senior structured products professionals drawn from the likes of Barclays, J.P. Morgan, Deutsche Bank and Natixis. 

Even if Credit Suisse is fully hedged against the declining value of the XIV ETN, other banks may not be. The Bloomberg chart below, showing holders of the product in September (the last date for which figures are available), suggests Deutsche Bank was also exposed to losses of around $60m. That's not going to break the German bank. Nor, however, is it good news in a year when Deutsche's bonus pool looked dubious anyway and the bank is promising to finalize its payouts only after reviewing events in the first quarter.

A thread on the mechanics of XIV:

— Charles Forelle (@charlesforelle) February 6, 2018

XIV bonuses

Source: Bloomberg

Photo credit: JohnnyPowell/Getty

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