The Securities and Exchange Commission (SEC) has put at least a temporary halt to certain actively managed and leveraged exchange traded funds (ETFs) in registration while the agency as examines the funds’ use of derivatives.

The purpose of the look is to see what, if any, protections are needed so investors don’t get burned using such funds. Although the SEC said it is putting on hold new ETFs that would make “significant investments” in derivatives, the move won’t impact ETFs already trading, reports John Spence for MarketWatch.

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.

Leveraged and inverse ETFs aren’t the only funds that use derivatives; some commodity ETFs also access the futures market by using them, too, but it’s not clear whether the SEC is looking at them, too.

Among the factors that the SEC will be examining:

  • Whether the current practices in the market are consistent with the diversification provisions until the 40 Act, writes Peter Ortiz for Ignites.
  • Whether funds that rely on derivatives keep and maintain proper risk management.
  • Whether these funds activities in derivatives should be subject to certain reporting requirements.

For more stories about ETFs, visit our ETF 101 category.

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.