SEC Pushes Back on High-Leverage SEC ETFs to Protect Investors

The US Securities and Exchange Commission (SEC) has signaled its opposition to high-leverage exchange-traded funds (ETFs). The regulator sent a letter to ETF issuers.

It addressed those seeking to list leveraged SEC ETFs with more than 2 times exposure. ETF providers such as Tidal, Direxion, and Provixion all got the letters.

SEC ETFs Applications Halted Under Rule 18f-4

The SEC told ETF issuers in its letter that it has stopped all leveraged SEC ETFs applications. It blocked those offering more than 200% exposure to underlying assets. It further expressed concerns about this type of ETF.

It said:

For Direxion, the letter affected 30 3X high-leverage ETF applications for equities and crypto assets.  The SEC has now requested that the ETF providers revise their applications to ensure compliance with its rules.

According to the regulator, it is relying on  Rule 18f-4 under the Investment Company Act of 1940 to ban such high-leverage ETFs. The SEC claimed that the referenced rule limits fund leverage risk.

It said:

Interestingly, the SEC posted the letters on the website the same day it sent them to the issuers. Experts believe this is a clear signal that the SEC is strongly against risky leverage and wants to communicate.

Expert Support for SEC ETFs Halt on High-Leverage Products

Meanwhile, the SEC’s decision to halt applications for 3x leveraged SEC ETFs and above gained expert support. Many analysts believe the move will protect investors from excessive risk.

Senior ETF analyst at Bloomberg, Eric Balchunas, stated that this is for the best. According to him, allowing over 2X leverage will only lead to frequent termination events.

He said:

Alpha Architect CEO Wes Grey added that this is a sign that sanity prevailed at the SEC. Still, the emergence of multiple high-leverage ETFs demonstrates a strong appetite among investors for these products.

The cryptocurrency market, in particular, has seen increased liquidations in the current market cycle, according to data from Glassnode. The analytics firm notes that average daily liquidation in this cycle has been $68 million for longs and $45 million for shorts.

This is a sizable increase compared to $28 million and $15 million, respectively, in the last cycle. High leverage is a big factor behind this surge in liquidation.

However, open interest in crypto futures has declined in recent weeks following substantial price falls. Still, open interest is around 132 billion, and over $329 million has been liquidated today.

The regulator decided to block listings of leveraged SEC ETFs above 2X. This action shows its effort to balance investor protection with fostering innovation.