The U.S. Securities and Exchange Commission (SEC) has indicated uncertainty regarding whether recent filings for highly leveraged ETFs, such as Volatility Shares’ planned 5x products, would be approved, raising new questions about leverage limits in the U.S. market.
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Since the U.S. government shutdown, the SEC has seen a flood of 3x and 5x leveraged equities seeking ETF registration statements, said Brian Daly, director of the SEC’s division of investment management, according to Reuters. Daly said that it is uncertain whether these ETFs would be in compliance with the Derivatives Rule (Rule 18f-4), which primarily caps leverage at 2x.
Volatility Shares submitted on Wednesday for 27 extremely leveraged ETFs, which include the first-ever to propose a 5x ETF in the U.S. market. The 5x target implies that the fund would seek to quintuple the day’s return on an underlying stock or asset, a dramatic increase from the 2x limit previously sanctioned for single-stock leveraged ETFs. Among the new leveraged ETFs are those tied to Bitcoin, Tesla and Strategy.
If sanctioned, the suite would consist of 27 products across 3x and 5x leverage levels, effective as of Dec. 29, making them perhaps the riskiest crypto-tied products offered to American investors.
ETF specialists warn that such extreme leverage poses tremendous risks. Analysts pointed out that among such ETFs that were launched more than three years ago, over half have closed and 17% have lost over 98% of their value over their lives.
Amplifying returns also amplifies losses, and broad-based selling from leveraged ETFs can exacerbate market declines, as seen last week when $26 billion of ETF selling added to a market sell-off triggered by U.S.–China trade tensions.
The filings arrive during a period when the SEC is working with skeletal personnel because of the shutdown, which restricts its capacity to read filings, pursue misconduct, and police markets.
Volatility Shares’ filings, which cover both 3x and 5x ETFs tied to Bitcoin treasury trailblazer Strategy Inc (NASDAQ:MSTR), are set to take effect 75 days after filing. According to analysts, while this SEC management has been more open to creative approaches, 5x leveraged single-stock ETFs can push regulatory boundaries.
For investors, the developments highlight both the promise and the danger of excessive leverage. While there is potential for outsized gains, the combination of compounding that occurs on a daily basis, volatile underlying assets and limited regulatory scrutiny might make these products among the most risky in U.S. markets.
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