SEC Cracks Down on 3x and 5x Leveraged Crypto ETFs

• SEC formally blocked 3x and 5x leveraged crypto ETF applications from multiple issuers including Direxion and VolShares.
• Rule 18f-4 limits fund leverage to 2x benchmark risk, preventing approval of extreme leverage products.

The​‍​‌‍​‍‌​‍​‌‍​‍‌ Securities and Exchange Commission has made a major move against the crypto investment environment by rejecting several proposals for leveraged exchange-traded funds. Managers of funds who want to introduce 3x and 5x crypto ETFs have to make a very important choice now: whether to change their tactics drastically or to take back their applications.

The elimination of these proposals by the regulator comprises a large number of the crypto-related and high-volatility equities filings, which may be interpreted as a warning from the Commission about too much risk in the ​‍​‌‍​‍‌​‍​‌‍​‍‌market.

Regulatory Concerns Over Extreme Leverage

The​‍​‌‍​‍‌​‍​‌‍​‍‌ SEC intervention is mainly about Rule 18f-4, which lays down very detailed risk control regulations for funds using derivatives as part of their investment portfolios. As per Bloomberg analyst Eric Balchunas, the regulators charged the issuers with the intention of exploiting loopholes to avoid the value-at-risk restrictions, which are presently at 200%. 

The rule forbids the funds from going beyond twice the risk level of their benchmark index, and at the same time makes it obligatory to have continuous monitoring in place. Direxion was singled out, among others, in the regulatory communication for having filed proposals for leveraged products that track both cryptocurrency assets and high-beta stocks. 

The Commission’s worries are not just about the crypto world but also include heavily leveraged single-stock strategies and concentration of sector-based products that, by their nature, could cause market ​‍​‌‍​‍‌​‍​‌‍​‍‌instability. 

The​‍​‌‍​‍‌​‍​‌‍​‍‌ Director of the Investment Management Division, Brian Daly, emphasized the significant increase in the filings related to extreme leverage, and he mentioned that the agency received a large number of registration statements for 3x and 5x products. In October, VolShares filed for quintuple-leveraged ETFs tracking Solana, Ethereum, and XRP, along with similar products for Tesla, Nvidia, and Coinbase shares. 

At the same time, GraniteShares was seeking the green light for a triple-leveraged XRP fund, thus adding to the regulatory backlog that the Commission is facing. Bryan Armour, a researcher at Morningstar, brought a sad reality to the fore, stating that more than half of the leveraged ETFs that have been launched recently have already shut down their operations in a permanent manner. 

In spite of the fact that SEC Chair Paul Atkins was promising innovation exemptions and expressing his support for the development of digital assets, it seems that extreme leverage products are going beyond the regulatory boundaries. The Commission is of the view that if leverage beyond the current limits is allowed, it could lead to very frequent termination events and thus create an unstable market situation which would be very ​‍​‌‍​‍‌​‍​‌‍​‍‌dangerous.

Highlighted Crypto News Today: 

Vanguard Opens Doors to Crypto Trading for 50 Million Clients