C Suisse CEO on controversial volatility trades: 'It worked well for a long time until it didn't'

Tidjane Thiam

Credit Suisse is defending a controversial financial product it issued that played a role in the staggering market losses last week.

Credit Suisse is defending a controversial financial product it issued that played a role in the staggering market losses last week.

People shorted volatility at their own risk, Credit Suisse CEO Tidjane Thiam told CNBC on Wednesday, when asked about the losses suffered by investors who used complex volatility trading tools, issued by several firms including his bank.

On Monday last week, as markets sold off and the Dow Jones industrial average plunged nearly 1,600 points in its biggest drop ever, many analysts pointed to the XIV as having amplified selling.

The XIV stands for the VelocityShares Daily Inverse VIX Short-Term exchange-traded note (ETN). The product, managed by Credit Suisse and of which it owns 32 percent, shorts volatility by betting on calm market conditions. It has increased in popularity in the past year as volatility in the Cboe Volatility Index (VIX) — a fear gauge for the stock market — reached historic lows.

But because the XIV was designed to produce opposite returns of the VIX, when the volatility index shot through the roof Monday — a record 118 percent — the XIV went through the floor, down a devastating 90 percent. The ensuing negative feedback loop of selling is believed to have seriously exacerbated Monday's market turmoil.

Thiam said that the product's prospectus made clear it was meant for daily trading rather than long-term holding, emphasizing that investors were warned about the potential risks. The exchange-traded notes (ETNs), worth a combined $1.6 billion the previous Friday, lost 92 percent of their value by Tuesday's end, forcing credit Suisse to close the fund.

"It's not a proper investment vehicle," Thiam said. "So we also said because of that, because the price can vary so brutally, the prospectus says that if the price goes down 80 percent, we can close it."

When the VIX went from a low of 17 points to end the day at 38, the value of the instrument (the XIV) went from 100 to 5. "And once you're at 5, given the structure of the note, there is no prospect of recovery … The product was basically not usable anymore," he added.

The Switzerland-based bank announced last week that it has experienced no losses from its financial instrument. Instead, it appeared the fallout was squarely borne by investors holding the product.

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