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SEC warns about the risks of high-leverage ETFs
Investing.com - The U.S. Securities and Exchange Commission (SEC) requested leverage ETF issuers to halt plans for launching a new wave of funds during a brief conference call on Monday, expressing concerns about the increasingly aggressive fund structures.
According to six informed sources, the SEC’s Investment Management Division held this call with independent trustees and fund legal advisors. Participants said the call lasted only a few minutes with no Q&A session. The agency instructed participants to relay to issuers that they should not allow their proposed products to become effective. Effectiveness is the step that activates fund registration and allows the launch.
The core issue is whether the new generation of ETFs complies with regulatory limits on fund risk relative to assets. Some proposed funds aim to deliver returns equivalent to five times the daily return of the underlying index.
The proposed products by issuers need to meet the requirements of Rule 18f-4, which is SEC’s derivatives risk management rule. Regulators remain uncertain whether these products comply with the regulations.
Leverage ETFs use derivatives to amplify the daily returns of the underlying assets, meaning gains and losses are similarly magnified. Due to daily leverage resets, long-term returns can significantly diverge from the multiples implied by the fund’s name. These products were once niche tools for professional traders but have gained popularity among retail investors attracted by the prospect of earning excess returns in volatile markets.
Rule 18f-4 was adopted in 2020 to modernize fund management of derivatives by requiring funds to limit risk values relative to a reference benchmark.
According to data compiled by Bloomberg Intelligence’s Athanasios Psarofagis, since the launch of the first single-stock funds in 2022, the U.S. has introduced over 450 leveraged and inverse single-security ETFs. The asset size in this category has grown to about $150 billion, including index-based leveraged funds launched before 2022. Currently, there are no 5x or 3x single-stock ETFs in the U.S.
This article was translated with the assistance of artificial intelligence. For more information, please see our Terms of Use.