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The curious incident at Barclays

Barclays has got itself into trouble with its structured products and exchange traded notes (ETN) business in the US. The estimated loss is £450 million. There are good articles on Bloomberg and the Financial Times on what went wrong. Barclays has set up an independent review. Regulators on both sides of the Atlantic are also looking into it.

There is something very curious about this. This was not due to trades that went wrong, or wrong models used in pricing up structured notes. It is unlikely that fraud was involved. No insider in the bank seems to have benefited. It is just due to … err … a filing error.

To sell structured notes in the US, an issuer needs to tell the SEC how much it thinks it can sell. That is known as the “shelf registration statement”. In essence, you are informing the SEC that you will have certain capacity for your structured notes business. This is just a filing. No other action like provisioning risk capital is required.

In 2019, Barclays filed with the SEC that it intended to sell $20 billion in structured notes. This number looks big. But there is a good reason. Every time you sell some structured notes (or ETNs), you reduce the number on the shelf (shelf takedown) as your capacity is used up. When the shelf drops to a very low level, you will file another shelf registration statement with the SEC to say I am increasing the capacity again. So, it is better to tell the SEC a big number every time you file a shelf registration statement.

What seems to have happened is that someone inside Barclays (likely to be in the product control or documentation team) forgot to keep track of the running capacity of the shelf. And for some reason, which we will hopefully find out later, the shelf has not been updated since 2019 (!). It is a bit like your kid drawing money regularly from your bank account, but your bank statements have not shown these withdrawals over the last few years.

Of course, there is a difference between the bank statement example and Barclays’ case. In the bank account example, you will end up overdrawn and owe the bank money. For Barclays, the original $20 billion number filed on the shelf registration statement in 2019 was made up. It is not a number that affects its balance sheet, income statement or regulatory capital.

The problem was that once the shelf has gone down to zero (estimated to be about 12 months ago), and Barclays kept selling notes, those sales became illegal. As the notes were illegally sold, regulations require Barclays to buy back these notes from investors at par. Such “recission” won’t be a problem if those notes are currently trading above par. But with stock prices falling so far this year, Barclays will be losing money to buy back these notes. Ouch.

In the UK and Europe, similar capacity limits are stated in the prospectus of many structured notes programmes. Banks update them regularly, typically annually or when there are regulatory changes. An issuer should not issue more than what it says on the prospectus. So banks also look at the capacity limits carefully, and if needed they will update the prospectus or set up new issuing programs. So far, no incident like Barclays in the US happened on this side of the Atlantic, probably due to different capital market rules and reporting requirements (e.g. MiFID II)

Barclays appears to have an internal control issue and appears lax in operational risk management. Many investors got worried whether the error is just the tip of the iceberg and sold the stock, especially since this incident delayed the share buyback plan. Barclays’ stock price has fallen several days in a row since the news came out.

But there is also a risk management lesson for all of us, in business management and in personal lives. Overlooking something that you think is trivial (like keeping track of a made-up number) can be very expensive. Yes, you probably can get away with it 99.9% of the time. But when that 0.1% probability hits you, it will cost you a lot.

James Chu CFA

Head of Investment Solutions

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