SEC Warns Issuers: Ultra-Leveraged 3x and 5x ETFs Won’t Bypass 200% VAR Cap

• U.S. SEC has warned issuers that filed leveraged 3x and 5x ETFs would not bypass the 200% VAR limit.
• SEC is yet to approve ultra-leveraged ETFs filings in the U.S., despite greenlighting some altcoin ETFs.

The U.S. Securities and Exchange Commission (SEC) recently challenged the industry’s attempt to launch 3x and 5x leveraged crypto ETFs. The agency warned that the exchange-traded funds (ETFs) would not bypass the 200% Value-at-Risk (VAR) limit under Rule 18f-4.

SEC Push Back on Ultra-Leveraged 3x and 5x ETFs

Bloomberg senior ETF analyst Eric Balchunas commented on X that the SEC is pushing against all leveraged 3x and 5x ETF filings.

Balchunas shared an email copy sent by the SEC’s Division of Investment Management to attorney Stacy L. Fuller of K&L Gates LLP. 

Fuller is the representative of Direxion Shares ETF Trust, which submitted post-effective amendments on October 3 and 10, attempting to register new leveraged series. 

In the email, the regulator formally objects to the trust’s proposed fund structures. They expressed concerns regarding the registration of ETFs seeking to provide more than 200% leveraged exposure.

The trust had filed amendments on Form N-1A for several traded funds listed in an attached appendix. The SEC, however, countered the filing. The regulator said it would not complete a full review until the leverage issues outlined in its correspondence were resolved.

In the email, the SEC mentioned Rule 18f-4 under the Investment Company Act of 1940, referred to as the Derivatives Rule. This rule limits an open-end fund’s risk exposure by ensuring its VAR does not exceed 200% of a designated reference portfolio risk. 

Accordingly, any ETF seeking more than 2x leverage under these conditions must meet very concise alternative testing requirements issued by the SEC. If they fail to meet these conditions, they can withdraw the application entirely.

Balchunas thinks blocking all leveraged 3x and 5x ETFs is actually good, even though he is very pro-free market. His sentiment is based on concerns that real-world volatility would cause ultra-leveraged funds to hit their VAR limits. 

When this happens, the fund either has to reduce leverage or trigger a termination event and liquidate.

Ultra-Leverage ETF Filings Flood the SEC Table

The SEC’s latest objections follow public warnings issued in October. At the time, the SEC expressed doubt whether dozens of leveraged ETF applications filed could comply with federal limits. 

Brian Daly, Director of the SEC’s division of investment management, said ETF applicants had flooded their tables with filings for leverage products. The issuers submitted the filings during the shutdown of the US government.

For instance, ETF issuer Volatility Shares submitted proposals for 27 ultra-leveraged ETFs. If the SEC had given its approval, this would have been the first 5x leveraged ETF products in the United States.

Meanwhile, Teucrium launched the first U.S. ETF offering 2x daily leveraged exposure to XRP, as we previously discussed. This product is complete with Ticker XXRP, which became available on the NYSE Arca.

A few months later, specifically in August, Tidal Trust II filed for a leveraged long XRP ETF with exposure to XRP. The proposed ETF is expected to provide leveraged exposure of 150% to 200% in the daily change in XRP price.

In a related development, NYSE ARCA has officially approved the listing of Franklin Templeton’s spot XRP ETF. 

As featured in our recent coverage, this XRP ETF began trading on November 24, under the ticker symbol XRPZ. Also note that the SEC has approved 21Shares’ spot XRP ETF for the U.S. market.