FINRA Puts New Restrictions on Leveraged ETFs

The Financial Industry Regulatory Authority (FINRA) will implement increased margin requirements for leveraged exchange-traded funds (ETFs).

Leveraged ETFs are designed to generate multiples of the ups and downs of the underlying index or benchmark they track. Inverse or short leveraged ETFs seek to deliver the opposite of the performance of the index or benchmark they track.

Because of the volatility of those instruments, FINRA has warned firms of their danger, particularly if investors think it can be a long-term strategy. A handful of broker/dealer firms have reined in or banned the sale of leveraged ETFs altogether (see “Edward Jones Puts Brakes on Leveraged ETFs” and “MSSB Bans Leveraged ETF Sales”).

Effective December 1, FINRA will increase the required amount an investor must deposit with a broker before borrowing to invest in the leveraged ETFs. Currently, the maintenance margin requirement is 25% of the market value for any long ETF and 30% of the market value for any short ETF. The maintenance margin requirements will go up by a percentage corresponding with the leverage of the ETF, not to exceed 100%, according to FINRA Regulatory Notice 09-53.

FINRA noted that ETFs are not the only instruments using the strategy; other products such as leveraged mutual funds can be held and traded in customer accounts on a margin basis. “As such, firms are reminded to assess the adequacy of current maintenance requirements for these products and the need to increase them where appropriate,” the regulator said.