The U.S. Securities and Exchange Commission (SEC) has effectively shut down the launch of highly leveraged ETFs that aim to triple or even quintuple daily returns on stocks, commodities, and cryptocurrencies.
The agency sent nine separate warning letters to the most active issuers in this area, such as Direxion, ProShares, and Tidal, informing them that the planned products would not be subject to review.
The letters stated that the risk levels of these ETFs could exceed the SEC's permitted limits based on fund assets. Therefore, the regulator asked the companies to either restructure their strategies or withdraw their applications entirely. The letter, sent to all applicants, stated, “We are concerned about the registration of ETFs that aim to provide leveraged exposure greater than 200% (2x).”
Regulatory Restraint in a Growing Market
This move stands out as a significant restraint in an era of lax regulation, which has recently seen crypto-linked ETFs, particularly those that have been gaining approval easily, become increasingly widespread. These products, which have caught the SEC's attention, represent the most extreme examples of this trend due to their high leverage, daily reset mechanism, and exposure to individual stocks like Tesla and Nvidia, as well as highly volatile digital assets like Bitcoin and Ethereum.
One of the regulator's main concerns is that the “reference assets” used by funds in their risk metrics don't accurately reflect their target volatility. “Issuers were trying to go beyond the 2x limit, and the SEC was clearly reluctant to do so,” said Todd Sohn, an ETF strategist at Strategas. “They were trying to find a loophole by using certain definitions.”
Specific Products and Existing Regulations
Some of the funds mentioned in the warning letters were 5x leveraged ETFs recommended by Volatility Shares. These funds aimed to multiply daily returns by five times on highly volatile stocks like Tesla and Nvidia, as well as digital assets like Bitcoin and ETH. Currently, there are no single-stock ETFs with 3x or 5x leverage in the US; SEC regulations have long effectively limited the leverage level of such products to 2x.
Leveraged ETFs: Popularity and Risks
Leveraged ETFs, which multiply returns through options trading, have gained popularity, particularly among investors seeking quick returns. Trading volumes have increased sharply in the post-pandemic period, with the sector's total assets reaching $162 billion. However, these products have long been a target of criticism: their opaque nature and high risks are frequently cited as dangerous for amateur investors. In Europe, GraniteShares' 3x Short AMD product was completely wiped out in October after AMD shares surged sharply in a single day, and the fund was shut down.