The U.S. Securities and Exchange Commission (SEC) has rejected applications for 3x and 5x leveraged exchange-traded funds (ETFs), citing violations of federal leverage limits under Rule 18f-4. This decision prevents funds from exceeding 200% Value-at-Risk (VaR), protecting investors from excessive risks in volatile markets like crypto and equities.
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SEC’s Rule 18f-4 caps leverage at 2x for open-end funds, blocking higher multiples to mitigate portfolio risks.
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Filings from issuers like Direxion and Volatility Shares attempted loopholes but were formally objected to by regulators.
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Over 50% of single-stock leveraged funds launched more than three years ago have shut down, highlighting the dangers of ultra-leverage with 17% losing over 98% value, per Morningstar data.
SEC rejects 3x and 5x leveraged ETFs amid Rule 18f-4 concerns, safeguarding investors from high-risk products. Discover regulatory impacts on crypto and stock funds—read now for key insights and expert analysis.
What is the SEC’s Stance on 3x and 5x Leveraged ETFs?
The SEC’s stance on 3x and 5x leveraged ETFs involves strict enforcement of leverage limits to protect investors from undue risks. In recent correspondence, the agency formally objected to filings seeking more than 200% leveraged exposure, requiring issuers to either revise strategies to comply with Rule 18f-4 or withdraw applications. This move addresses potential loopholes that could expose funds to excessive volatility, particularly in sectors like cryptocurrencies where price swings are common.
How Does Rule 18f-4 Impact Leveraged ETF Applications?
Rule 18f-4, known as the Derivatives Rule under the Investment Company Act of 1940, serves as the primary barrier for ultra-leveraged ETFs by limiting an open-end fund’s Value-at-Risk (VaR) to no more than 200% of a reference portfolio’s risk. Funds aiming for 3x or 5x leverage must undergo rigorous alternative testing or face rejection, as outlined in SEC communications to applicants like Direxion Shares ETF Trust. Bloomberg ETF analyst Eric Balchunas noted that several issuers tried exploiting filing nuances to bypass this cap, but the regulator’s response emphasizes compliance to prevent termination events from daily resets in volatile assets.
Supporting data from Balchunas’ review reveals 350 instances over five years where stocks in proposed 3x ETF filings swung by 33% or more in a single day—enough to wipe out a 3x product entirely. Morningstar ETF analyst Bryan Armour added that among single-stock funds over three years old, more than half have liquidated, with 17% suffering losses exceeding 98% due to compounding decay and market turbulence. “This SEC administration has been more amenable to new strategies, but 5x leveraged single-stock ETFs will test those limits,” Armour stated in comments to Reuters.
The rule’s structure promotes stability by mandating risk management programs, including stress testing and board oversight, which become increasingly challenging at higher leverage levels. In the crypto space, where assets like Bitcoin can fluctuate dramatically, these safeguards are crucial to avoid “max pain” for retail investors, as Armour described. Issuers must now align objectives with the 2x threshold, potentially curtailing innovation but enhancing long-term fund viability.
Frequently Asked Questions
Why Did the SEC Reject 3x and 5x Leveraged ETF Filings in 2025?
The SEC rejected these filings due to non-compliance with Rule 18f-4, which restricts leverage to 2x to limit VaR exposure. Applications from Direxion and Volatility Shares, submitted in October 2025, attempted workarounds but prompted formal objections, as shared by analyst Eric Balchunas. Regulators aim to prevent excessive risks from daily resets in volatile markets, ensuring investor protection without speculation on untested structures.
What Are the Risks of Investing in Leveraged ETFs Beyond 2x?
Investing in leveraged ETFs beyond 2x amplifies losses from daily price swings and compounding decay, often leading to total erosion of value over time. For instance, a 33% stock drop could liquidate a 3x fund entirely, based on historical data from 66 stocks analyzed by Eric Balchunas. In voice search terms, these products suit short-term trading only, not buy-and-hold, due to frequent terminations and regulatory caps designed for stability.
Key Takeaways
- Regulatory Enforcement Strengthens Investor Safety: The SEC’s adherence to Rule 18f-4 blocks 3x and 5x ETFs, reducing exposure to extreme volatility in crypto and equity markets.
- Historical Data Underscores Dangers: Over 50% of older single-stock leveraged funds have closed, with significant value destruction highlighting the perils of ultra-leverage, per Morningstar insights.
- Future Filings Must Comply or Withdraw: Issuers should focus on 2x strategies to avoid rejection, fostering sustainable innovation while heeding expert warnings on risk management.
Conclusion
The SEC’s rejection of 3x and 5x leveraged ETF applications under Rule 18f-4 reinforces a commitment to balanced risk in investment products, particularly amid rising interest in crypto-linked funds. By addressing potential loopholes and mandating VaR compliance, regulators mitigate dangers from daily resets and market swings, as evidenced by expert analyses from Bloomberg and Morningstar. As the ETF landscape evolves, investors can anticipate more stable options; stay informed on compliance updates to make prudent decisions in this dynamic sector.
Looks like SEC is pushing back on all the 3x and 5x filings, calling them out on the loophole they were trying to use, to get around the 200% VAR, and “requests them to revise the obj and strategy to be consistent with 18f-4 or withdrawal” Honestly, it’s for the best. I’m as… pic.twitter.com/J8p6o1ND2B
— Eric Balchunas (@EricBalchunas) December 2, 2025
