Last week, the Securities and Exchange Commission (SEC) said it would temporarily halt the approval certain exchange traded funds (ETFs) currently in registration while it looks at how they use derivatives. This week, the SEC is making some clarifications to that statement.

There are industry concerns that the SEC is denying applications for actively managed and leveraged ETFs that use derivatives, but the SEC says it isn’t; it’s simply deferring them, Peter Ortiz for Ignites explains. The purpose of the look is to see what, if any, protections are needed so investors don’t get burned using such funds.

The SEC feels that ETFs that make significant investments in derivatives are a large risk. The SEC says that applications for funds that use significant amounts of derivatives “can move forward” as long as the funds agree to restrict the use of certain derivatives. [Why the SEC Is Looking At These Funds.]

Reasons the SEC is putting leveraged and inverse ETFs using derivatives under the microscope include:

  • These ETFs can see huge one-day swings, and they’re not suitable for most buy-and-hold investors. The products use derivatives and swaps to allow investors to get daily leverage, and bet against markets. [A Leveraged ETF Experiment.]
  • Some investors have been confused by the funds, leading to a push for more clarity and education. In 2009, the SEC and the Financial Industry Regulatory Authority (FINRA) put forth an alert because they believed individual investors may be “confused” by their performance. [Everything You Should Know About Leveraged and Inverse ETFs.]
  • They’re very popular. Data show that there are 70 leveraged bullish ETFs with $11.2 billion in assets under management at the end of February. Meanwhile, there were 76 leveraged bearish ETFs with $16.6 billion.

The agency’s decision to review the use of derivatives by all funds led it to defer its review of pending and new requests for exemptive relief of the actively managed and leveraged ETFs. None of this is going to affect any funds already trading.

To know everything there is to know about leveraged and inverse ETFs, read our free special report.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.