SEC Clamps Down: Leveraged ETF Proposals Slammed for Blowing Past 200% VAR Limit
The SEC just drew a line in the sand—and some ambitious ETF proposals just crossed it.
Regulators are pushing back hard against a wave of filings for high-octane leveraged funds. The core issue? A risk metric that's flashing red. These products are designed to amplify returns, but the agency says their proposed strategies would routinely exceed a critical 200% Value at Risk (VAR) threshold. That's a level the SEC views as the outer limit for what's acceptable in a retail-facing product.
Why the VAR Limit Matters
Think of VAR as a fund's worst-case-scenario gauge for a typical trading day. A 200% limit means the product shouldn't, under normal conditions, be positioned to lose more than twice its net asset value in a single session. For regulators, it's a guardrail against catastrophic, wipeout-level losses for everyday investors who might not grasp the sheer volatility they're buying into.
The funds in question aim to deliver daily returns that are a multiple—think 2x, 3x, or more—of an underlying index. To hit those targets, they use derivatives and debt, strategies that inherently juice the VAR score. The SEC's message is clear: the math doesn't lie, and your math breaks our rules.
A Chilling Effect on Innovation—Or a Necessary Brake?
This isn't a gentle suggestion; it's a regulatory roadblock. The pushback signals that the era of anything-goes in leveraged ETF design might be cooling off. Proponents argue these products are tools for sophisticated traders, clearly labeled with their risks. The SEC, it seems, is less convinced that disclaimers alone are sufficient when the potential for sudden, massive loss is baked into the blueprint.
It's a classic finance clash: the drive for innovative, high-performance products versus the mandate to protect the market from its own most dangerous impulses. After all, what's the finance industry without inventing new ways to package risk and then acting surprised when it actually materializes?
The ball is now in the issuers' courts. They can go back to the drawing board to tweak their strategies, mount a legal challenge, or shelve the plans altogether. One thing's certain: getting a triple-leveraged anything past the watchdogs just got a whole lot harder.
Regulators cite Rule 18f-4 as core obstacle
The SEC’s letter mentioned Rule 18f-4 under the Investment Company Act of 1940, referred to as the Derivatives Rule, which limits an open-end fund’s risk exposure by ensuring its Value-at-Risk (VAR) does not exceed 200% of a designated reference portfolio risk.
Any ETF seeking more than 2x leverage under these conditions must either meet very concise alternative testing requirements issued by the SEC or withdraw the application entirely. In its correspondence, the US securities regulator asked the issuer to “revise the obj and strategy to be consistent with 18f-4 or withdrawal,” comments that were cited on Bloomberg’s Balchunas X post.
The crypto ETF analyst mentioned several issuers had tried to exploit a loophole to exceed the 200% VaR limit while submitting filings with the SEC to make it more “favorable.”
“Honestly, it’s for the best. I’m as libertarian as they come, and I think 2x is plenty of heat; any more and we’d have termination events regularly, which would be a constant distraction,” Balchunas wrote.
Ultra-leveraged filings in October yet to be approved
The regulator’s latest objections follow several of its public warnings issued in October, when the SEC said it was “unclear” whether dozens of highly leveraged ETF applications filed in the preceding weeks could comply with federal limits.
Brian Daly, director of the SEC’s division of investment management, told Reuters at the time that during the shutdown of the US government, ETF applicants had flooded their tables with filings for leverage products.
“The agency has received a large number of registration statements for ETFs seeking to offer 3x and 5x leveraged, equity-linked exposure, but the question is whether these ETFs would comply with the Derivatives Rule (Rule 18f-4), which generally limits leverage to 2x.”
ETF issuer Volatility Shares submitted proposals for 27 ultra-leveraged ETFs, including what would have been the first 5x leveraged ETF in the United States if the SEC had provided a greenlight. Since the SEC has never approved a single-stock product with leverage greater than 2x, Volatility Shares’ proposal was ambitious, and by some measure, audacious.
“Killing the loophole probably saves normies from getting 3x rekt on 5x copium,” said one Crypto Twitter member, referring to the SEC’s enforcement of Rule 18f-4.
Leverage ETFs risky due to liquidation possibilities
According to Morningstar ETF analyst Bryan Armour, among single-stock funds launched more than three years ago, more than half have shut down, while 17% lost over 98% of their value during their lifetime.
Armour believes volatile price swings and decaying value caused by daily resets would expose leveraged product investors to “max pain.”
“This SEC administration has been more amenable to new strategies coming to market, but 5x leveraged single-stock ETFs will test those limits,” he told Reuters.
Moreover, Balchunas also conducted an independent data review in October, finding 350 instances in the past five years where one of the 66 stocks included in recent 3x ETF filings experienced a daily swing of 33% or more, large enough to erase a 3x leveraged product entirely.
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