The Financial Industry Regulatory Authority (FINRA) has been warning brokerages and investors of the dangers that leveraged ETFs pose all year. This past week, they announced a raising of the margin requirements for these products and I think this was a very smart move.
By now, most investors are aware of the erosion involved when holding leveraged ETFs over extended periods of time because of the compounding effect. FINRA has already addressed this issue in a Notice To Members bulletin that led to the banning of these products outright by many large brokers and the tightening of internal policies by most other firms.
What FINRA is doing by raising margin requirements is addressing another aspect of the double and triple ETFs entirely: their inherent volatility.
From ETF Trends:
The requirements will be increased “by a factor commensurate with their leverage.” The current requirement for a long ETF is 25% of the ETF’s market value; the new requirement would be 50%. In a triple leveraged ETF, the requirement would be 75%. In a short ETF, the margin requirement is 30% of the ETF’s value; it would double to 60% under the new rules.
This is exactly the kind of common sense rule-making that our regulators should be engaging in. It helps to wring out some of the speculative excess in these types of products and limits the potential for people who don’t know any better to blow themselves up. The products themselves are volatile enough without the use of borrowed money to bring even more exposure to an investor’s portfolio.
I also think that this is a great compliment to FINRA’s prior commentary on leveraged ETFs from earlier this summer on how the products tend to work better on an intraday basis. If people are going to be daytrading these funds, the new margin requirements will reign in some of the more over-the-top trades that may have been allowed or encouraged in the past.
The new rules will take effect at your brokerage firm by December 1st. I applaud FINRA’s decision to toughen up on margin requirements. This smart move stands in contrast with the foot-dragging of other regulatory bodies, the CFTC (Commodities & Futures) for example, who are still clueless or indifferent as to the dangers and abuses of unrestrained leverage.
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