The U.S. Securities and Exchange Commission (SEC) has effectively halted 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 the space, including Direxion, ProShares, and Tidal, informing them that their proposed products would not be subject to review.
The letter stated that the risk level of these ETFs could exceed the SEC's allowable limits based on the fund's assets. Regulators have therefore asked companies to either restructure their strategies or withdraw their applications altogether. A letter sent to all applicants stated, “We are concerned about the registration of ETFs intended to provide leverage exposure in excess of 200% (2x).”
The move stands out as a significant restraint in recent times, especially in an era of loose regulation where crypto-linked ETFs have become increasingly popular, with easy approvals. These products that have attracted the attention of the SEC represent the most extreme examples of this trend, as they feature high leverage, daily reset mechanisms, and exposure to individual stocks such as Tesla and Nvidia, as well as highly volatile digital assets such as Bitcoin and Ethereum.
One of the regulators' main concerns is that the “reference assets” used by funds in their risk metrics do not accurately reflect their target volatility. “Issuers were trying to exceed the 2x limit, but the SEC was clearly reluctant to do so,” said Todd Thorne, ETF strategist at Strategas. “They were trying to find a loophole using a specific definition.”
Some of the funds mentioned in the warning letter were 5x leveraged ETFs recommended by Volatility Shares. These funds aimed to quintuple daily returns on volatile stocks like Tesla and Nvidia, as well as digital assets like Bitcoin and ETH. There are currently no 3x or 5x leveraged single stock ETFs in the US. SEC regulations have long effectively limited leverage levels on such products to 2x.
Leveraged ETFs, which double returns through option trading, are gaining popularity, especially among investors looking for quick returns. Post-pandemic trading volumes have increased sharply, with total assets in the sector reaching $162 billion. However, these products have long been the subject of criticism. Its opaque nature and high risk are often cited as dangerous for amateur investors. In Europe, GraniteShares' 3x Short AMD product completely disappeared in October and the fund was closed after AMD stock soared in a single day.
*This is not investment advice.
